This document outlines key concepts related to capital structure theory and policy. It discusses different approaches to the relationship between capital structure, cost of capital, and firm value, including: the net operating income approach; traditional approach; Modigliani-Miller hypotheses with and without taxes; and the trade-off theory. It also covers how the cost of equity relates to capital structure, interest tax shields, bankruptcy costs, and Miller's approach incorporating both corporate and personal taxes. The overall purpose is to understand theoretical debates on capital structure and how debt versus equity financing impacts firm value.
Mba 2 fm u 5 capital structure,dividend policyRai University
This document provides an overview of capital structure theory and policy. It discusses different theories on the relationship between capital structure, cost of capital, and firm value, including: the net operating income approach; traditional approach; Modigliani-Miller hypotheses with and without taxes; and the trade-off theory. It also covers how the cost of equity relates to capital structure and financial distress costs. Key points covered include the interest tax shield advantage of debt financing and how the optimal capital structure balances this benefit against financial distress costs.
The document discusses various factors that influence a company's capital structure and theories around optimal capital structure. It covers factors like financial leverage, growth, costs, and investor requirements. It also discusses reasons for changing capitalization like restoring financial balance or meeting legal needs. Several capital structure theories are examined, including the net income approach, net operating income approach, and MM hypotheses with and without taxes. The document also discusses concepts like indifference points, financial break even points, and how debt-equity mix can impact firm value.
This document discusses various theories of capital structure and their impact on firm value. It begins by outlining learning objectives around capital structure theories and their relationship to cost of capital and firm value. It then covers the net operating income, traditional, and Modigliani-Miller approaches. It discusses how taxes impact the MM hypotheses and introduces the trade-off theory weighing costs and benefits of leverage. The document also summarizes pecking order theory and approaches to establishing an optimal capital structure.
The document discusses capital structure decisions and theories. It begins by outlining the goals of maximizing firm value and minimizing the weighted average cost of capital (WACC) through lowering risk, increasing cash flows, and maximizing profits. It then discusses factors that affect capital structure such as business risk, debt tax deductibility, and managerial decisions.
The document goes on to provide definitions related to capital structure and explores how capital structure can impact value using the WACC and free cash flow models. It previews various capital structure theories including Modigliani-Miller with no taxes, corporate taxes, and corporate and personal taxes. Finally, it discusses the trade-off theory and how an optimal capital structure balances the tax
FIN 534 Week 8 Part 2 Capital Structure DecisionsSlide 1Intro.docxssuser454af01
FIN 534 Week 8 Part 2: Capital Structure Decisions
Slide 1
Introduction
Welcome to Financial Management. In this lesson we will discuss capital structure decisions.
Next slide
Slide 2
Topics
The following topics will be covered in this lesson:
A preview of capital structure issues;
Business risk and financial risk;
Capital structure theory;
Capital structure evidence and implications;
Estimating the optimal capital structure; and
Anatomy of recapitalization.
Next slide
Slide 3
A preview of capital structure issues
Managers should make capital structure decisions to maximize the intrinsic value of the firm. The firm’s capital structure is its mixture of debt and equity. While the actual levels of debt and equity may vary over time, most firms try to maintain a financing mix that is close to its target capital structure. Recall, the value of the firm’s operations is the present value of its expected future cash flows, FCF, discounted at the firm’s weighted average cost of capital, WACC. Mathematically, the value of the firm’s operations is given by the following equation:
V sub OP equals summation T equals one through infinity FCF sub T divided by the quantity one plus WACC raised to the tth power;
Where WACC equals w sub D times the quantity one minus T times R sub D plus W sub S times R sub S; and
WACC depends on the percentages of debt and common equity, W sub D and W sub S, the cost of debt, R sub D, the cost of equity, R sub S, and the corporate tax rate T. The only way any decision can change the firm’s value is by changing either FCF or its cost of capital. Debtholders’ claim on the firm’s cash flows rank ahead of the stockholders’ claim because they have a residual claim on the cash flows after debtholders’ are paid.
The fixed claim of debtholders increases the cost of equity, R sub S, because their residual claim becomes riskier. Interest expense is tax deductible which reduces the firm’s taxable income and therefore its tax bill. The tax reduction reduces the after-tax cost of debt which results in more income available to debtholders and other investors.
When the firm increases its debt level the probability of financial distress or bankruptcy increases. This results in an increased pretax cost of debt, R sub D, because debt-holders will require a higher interest rate. The net impact on the WACC is indeterminate because both R sub D and R sub S change because it is a weighted average of relatively low-cost debt and relatively high-cost equity. The risk of bankruptcy can reduce FCF and the value of the firm. When the risk of bankruptcy increases, customers may make purchases from another firm and hence sales decline which reduces net operating profit as well as FCF. Additionally any type of financial distress negatively impacts the productivity of managers and employees and reduces net operating profit after taxes, NOPAT, and FCF. Moreover the firm experiences a reduction in accounts payable and results in an ...
The document discusses capital structure and financial leverage. It defines capital structure as a firm's mix of debt and equity. Firms can alter their capital structure through activities like paying off debt with stock proceeds. Financial leverage refers to the extent a firm relies on debt financing. While debt provides a tax shield, it also increases the risks of bankruptcy costs if the firm cannot meet its debt obligations. The optimal capital structure balances the tax benefits of debt against the costs of financial distress.
Working Capital ManagementChapter 15Working Ca.docxdunnramage
Working Capital Management
Chapter 15
Working Capital Terminology
Working capital: current assets.
Net working capital:
current assets - current liabilities.
Net operating working capital:
current assets - (current liabilities - notes payable).
Working capital management:
controlling cash, inventories, and A/R, plus short-term liability management.
2
Working Capital Financing Policies
Aggressive: Use short-term financing to finance permanent assets.
Moderate: Match the maturity of the assets with the maturity of the financing.
Maturity Matching, or “Self-Liquidating”, approach
Conservative: Use permanent capital for permanent assets and temporary assets.
3
Cash Conversion Cycle
The cash conversion cycle focuses on the length of time between when a company makes payments to its creditors and when a company receives payments from its customers.
4
Cash Conversion Cycle
15-5
5
Cash Budget
Forecasts cash inflows, outflows, and ending cash balances.
Used to plan loans needed or funds available to invest.
Can be daily, weekly, or monthly, forecasts.
Monthly for annual planning and daily for actual cash management.
6
Cash and Marketable Securities
Currency
Demand Deposit
Marketable Securities
Inventories
Supplies
Raw materials
Work in process
Finished goods
Accounts Receivable: Credit Policy
Credit Period: How long to pay? Shorter period reduces days sales outstanding (DSO) and average A/R, but it may discourage sales.
Cash Discounts: Lowers price. Attracts new customers and reduces DSO.
Credit Standards: Restrictive standards tend to reduce sales, but reduce bad debt expense. Fewer bad debts reduce DSO.
Collection Policy: How tough? Restrictive policy will reduce DSO but may damage customer relationships.
9
Accounts Payable: Trade Credit
Trade credit is credit furnished by a firm’s suppliers.
Trade credit is often the largest source of short-term credit, especially for small firms.
Spontaneous, easy to get, but cost can be high.
10
period
deferral
Payables
period
collection
Average
period
conversion
Inventory
CCC
-
+
=
Capital Structure Policy
Chapter 13
Learning Objectives
Understand the difference between business risk and financial risk.
Use the technique of break-even analysis.
Understand capital structure theories.
Business Risk
Business Risk is the variation in the firm’s expected earnings attributable to the industry in which the firm operates.
Determinants of business risk:
The stability of the domestic economy
The exposure to, and stability of, foreign economies
Sensitivity to the business cycle
Competitive pressures in the firm’s industry
Operating Risk
Operating risk is the variation in the firm’s operating earnings that results from firm’s cost structure (mix of fixed and variable operating costs).
Earnings of firms with higher proportion of fixed operating costs are more vulnerable to change in revenues.
5
Operating Lev.
This document outlines key concepts related to capital structure theory and policy. It discusses different approaches to the relationship between capital structure, cost of capital, and firm value, including: the net operating income approach; traditional approach; Modigliani-Miller hypotheses with and without taxes; and the trade-off theory. It also covers how the cost of equity relates to capital structure, interest tax shields, bankruptcy costs, and Miller's approach incorporating both corporate and personal taxes. The overall purpose is to understand theoretical debates on capital structure and how debt versus equity financing impacts firm value.
Mba 2 fm u 5 capital structure,dividend policyRai University
This document provides an overview of capital structure theory and policy. It discusses different theories on the relationship between capital structure, cost of capital, and firm value, including: the net operating income approach; traditional approach; Modigliani-Miller hypotheses with and without taxes; and the trade-off theory. It also covers how the cost of equity relates to capital structure and financial distress costs. Key points covered include the interest tax shield advantage of debt financing and how the optimal capital structure balances this benefit against financial distress costs.
The document discusses various factors that influence a company's capital structure and theories around optimal capital structure. It covers factors like financial leverage, growth, costs, and investor requirements. It also discusses reasons for changing capitalization like restoring financial balance or meeting legal needs. Several capital structure theories are examined, including the net income approach, net operating income approach, and MM hypotheses with and without taxes. The document also discusses concepts like indifference points, financial break even points, and how debt-equity mix can impact firm value.
This document discusses various theories of capital structure and their impact on firm value. It begins by outlining learning objectives around capital structure theories and their relationship to cost of capital and firm value. It then covers the net operating income, traditional, and Modigliani-Miller approaches. It discusses how taxes impact the MM hypotheses and introduces the trade-off theory weighing costs and benefits of leverage. The document also summarizes pecking order theory and approaches to establishing an optimal capital structure.
The document discusses capital structure decisions and theories. It begins by outlining the goals of maximizing firm value and minimizing the weighted average cost of capital (WACC) through lowering risk, increasing cash flows, and maximizing profits. It then discusses factors that affect capital structure such as business risk, debt tax deductibility, and managerial decisions.
The document goes on to provide definitions related to capital structure and explores how capital structure can impact value using the WACC and free cash flow models. It previews various capital structure theories including Modigliani-Miller with no taxes, corporate taxes, and corporate and personal taxes. Finally, it discusses the trade-off theory and how an optimal capital structure balances the tax
FIN 534 Week 8 Part 2 Capital Structure DecisionsSlide 1Intro.docxssuser454af01
FIN 534 Week 8 Part 2: Capital Structure Decisions
Slide 1
Introduction
Welcome to Financial Management. In this lesson we will discuss capital structure decisions.
Next slide
Slide 2
Topics
The following topics will be covered in this lesson:
A preview of capital structure issues;
Business risk and financial risk;
Capital structure theory;
Capital structure evidence and implications;
Estimating the optimal capital structure; and
Anatomy of recapitalization.
Next slide
Slide 3
A preview of capital structure issues
Managers should make capital structure decisions to maximize the intrinsic value of the firm. The firm’s capital structure is its mixture of debt and equity. While the actual levels of debt and equity may vary over time, most firms try to maintain a financing mix that is close to its target capital structure. Recall, the value of the firm’s operations is the present value of its expected future cash flows, FCF, discounted at the firm’s weighted average cost of capital, WACC. Mathematically, the value of the firm’s operations is given by the following equation:
V sub OP equals summation T equals one through infinity FCF sub T divided by the quantity one plus WACC raised to the tth power;
Where WACC equals w sub D times the quantity one minus T times R sub D plus W sub S times R sub S; and
WACC depends on the percentages of debt and common equity, W sub D and W sub S, the cost of debt, R sub D, the cost of equity, R sub S, and the corporate tax rate T. The only way any decision can change the firm’s value is by changing either FCF or its cost of capital. Debtholders’ claim on the firm’s cash flows rank ahead of the stockholders’ claim because they have a residual claim on the cash flows after debtholders’ are paid.
The fixed claim of debtholders increases the cost of equity, R sub S, because their residual claim becomes riskier. Interest expense is tax deductible which reduces the firm’s taxable income and therefore its tax bill. The tax reduction reduces the after-tax cost of debt which results in more income available to debtholders and other investors.
When the firm increases its debt level the probability of financial distress or bankruptcy increases. This results in an increased pretax cost of debt, R sub D, because debt-holders will require a higher interest rate. The net impact on the WACC is indeterminate because both R sub D and R sub S change because it is a weighted average of relatively low-cost debt and relatively high-cost equity. The risk of bankruptcy can reduce FCF and the value of the firm. When the risk of bankruptcy increases, customers may make purchases from another firm and hence sales decline which reduces net operating profit as well as FCF. Additionally any type of financial distress negatively impacts the productivity of managers and employees and reduces net operating profit after taxes, NOPAT, and FCF. Moreover the firm experiences a reduction in accounts payable and results in an ...
The document discusses capital structure and financial leverage. It defines capital structure as a firm's mix of debt and equity. Firms can alter their capital structure through activities like paying off debt with stock proceeds. Financial leverage refers to the extent a firm relies on debt financing. While debt provides a tax shield, it also increases the risks of bankruptcy costs if the firm cannot meet its debt obligations. The optimal capital structure balances the tax benefits of debt against the costs of financial distress.
Working Capital ManagementChapter 15Working Ca.docxdunnramage
Working Capital Management
Chapter 15
Working Capital Terminology
Working capital: current assets.
Net working capital:
current assets - current liabilities.
Net operating working capital:
current assets - (current liabilities - notes payable).
Working capital management:
controlling cash, inventories, and A/R, plus short-term liability management.
2
Working Capital Financing Policies
Aggressive: Use short-term financing to finance permanent assets.
Moderate: Match the maturity of the assets with the maturity of the financing.
Maturity Matching, or “Self-Liquidating”, approach
Conservative: Use permanent capital for permanent assets and temporary assets.
3
Cash Conversion Cycle
The cash conversion cycle focuses on the length of time between when a company makes payments to its creditors and when a company receives payments from its customers.
4
Cash Conversion Cycle
15-5
5
Cash Budget
Forecasts cash inflows, outflows, and ending cash balances.
Used to plan loans needed or funds available to invest.
Can be daily, weekly, or monthly, forecasts.
Monthly for annual planning and daily for actual cash management.
6
Cash and Marketable Securities
Currency
Demand Deposit
Marketable Securities
Inventories
Supplies
Raw materials
Work in process
Finished goods
Accounts Receivable: Credit Policy
Credit Period: How long to pay? Shorter period reduces days sales outstanding (DSO) and average A/R, but it may discourage sales.
Cash Discounts: Lowers price. Attracts new customers and reduces DSO.
Credit Standards: Restrictive standards tend to reduce sales, but reduce bad debt expense. Fewer bad debts reduce DSO.
Collection Policy: How tough? Restrictive policy will reduce DSO but may damage customer relationships.
9
Accounts Payable: Trade Credit
Trade credit is credit furnished by a firm’s suppliers.
Trade credit is often the largest source of short-term credit, especially for small firms.
Spontaneous, easy to get, but cost can be high.
10
period
deferral
Payables
period
collection
Average
period
conversion
Inventory
CCC
-
+
=
Capital Structure Policy
Chapter 13
Learning Objectives
Understand the difference between business risk and financial risk.
Use the technique of break-even analysis.
Understand capital structure theories.
Business Risk
Business Risk is the variation in the firm’s expected earnings attributable to the industry in which the firm operates.
Determinants of business risk:
The stability of the domestic economy
The exposure to, and stability of, foreign economies
Sensitivity to the business cycle
Competitive pressures in the firm’s industry
Operating Risk
Operating risk is the variation in the firm’s operating earnings that results from firm’s cost structure (mix of fixed and variable operating costs).
Earnings of firms with higher proportion of fixed operating costs are more vulnerable to change in revenues.
5
Operating Lev.
This document discusses Mark Heath's assignment on corporate finance. It analyzes Modigliani and Miller's theories on capital structure and firm valuation. Specifically:
1) It applies their proposition I that firm value is unaffected by capital structure in a world without taxes to calculate the value of an unlevered and levered firm.
2) It discusses their proposition II that the weighted average cost of capital is also unaffected by capital structure when there are no taxes or transaction costs.
3) It examines how the introduction of corporate and personal taxes impacts firm valuation and the relationship between debt ratios and weighted average cost of capital. Bankruptcy costs are also considered in determining an optimal capital structure.
This document provides an outline and overview of capital structure and term structure theories. It discusses key concepts related to a firm's capital structure decision, including the net income approach, traditional views, Modigliani-Miller propositions, and theories such as trade-off, agency costs, and pecking order. It also covers term structure theories, including the expectations theory, segmented markets theory, and liquidity premium theory. The document uses examples and diagrams to illustrate how financial leverage, taxes, and bankruptcy costs impact a firm's optimal capital structure and cost of capital.
Financial leverage involves using debt to finance a firm's assets in order to increase expected earnings per share. While it increases expected returns, it also increases risk. There is no unique optimal capital structure, as changing leverage simply redistributes risk between shareholders and bondholders without changing firm value. According to the Modigliano-Miller propositions, capital structure is irrelevant in perfect markets with no taxes or bankruptcy costs.
The document provides financial information about Zip Zap Zoom Car Company over several years. It discusses the company's need to invest in upgrading technology and facilities to compete with increasing competition. It presents two views on determining the company's additional debt capacity. Mr. Shortsighted assumes a maximum 10% reduction in sales and 6% reduction in prices during a recession, and calculates the company can service Rs. 100 crore of additional debt. Mr. Longsighted argues a more probabilistic analysis of cash flows is needed that accounts for dividend payments and continued R&D/marketing spending. His analysis finds the company can service an additional Rs. 35 crore of debt while maintaining a 10% dividend with 95% certainty of adequate
This document summarizes key concepts regarding capital structure analysis:
1) EBIT/EPS analysis examines how different capital structures affect earnings available to shareholders and risk based on different levels of EBIT. Leverage increases EPS at high EBIT levels but decreases it at low levels.
2) Debt provides a tax shield benefit as interest payments reduce taxable income. This increases overall returns to investors compared to an unlevered firm.
3) There is a trade-off between the tax benefits of debt and the financial distress and agency costs of debt as leverage increases. Optimal capital structure balances these factors.
4) Practical considerations like industry standards, creditor requirements, maintaining borrowing capacity, and manager
The document discusses capital structure and leverage. It defines capital structure and discusses questions to consider when making financing decisions, such as determining the optimal financing mix. Appropriate capital structures should have features like profitability, solvency, flexibility, capacity, and control. Capital structure is determined by factors like taxes, flexibility, industry norms, and investor requirements. Firms can use different forms of capital structure involving various proportions of equity, debt, and preference shares. Financial leverage refers to using debt financing to magnify returns, and it can be measured using ratios like debt ratio and interest coverage. Capital structure theories address whether firm value depends on capital structure.
Capital structure decisions impact firm value. While the Modigliani-Miller theories concluded capital structure is irrelevant in perfect markets, other theories recognize costs like bankruptcy and agency costs. An optimal capital structure balances tax benefits of debt against these costs. Managers should consider their firm's risk level and investment opportunities to determine an appropriate capital structure.
The document discusses capital structure and various theories related to it. It defines capital structure as the combination of capital from different sources of financing. It then discusses factors that affect capital structure decisions like control, risk, cost, size and nature of business. It explains optimal capital structure as the perfect mix of debt and equity that maximizes firm value while minimizing cost of capital. It also discusses various methods of analyzing optimal capital structure including EBIT-EPS analysis and indifference point analysis. Finally, it summarizes different theories around capital structure like net income, net operating income, traditional and Modigliani-Miller approaches.
1. Read the information on the STREAMING VIDEO INDUSTRY and apply .docxjeremylockett77
This document provides instructions for analyzing three different cases related to industries and companies.
1. It asks the reader to analyze the streaming video industry using PESTEL, Porter, and strategic group analyses and discuss macroenvironmental factors impacting growth.
2. It asks the reader to analyze how the coronavirus impacts industry forces for two industries using macroenvironmental and industry analyses.
3. It asks the reader to interpret Tesla's strategy as disruptive or sustaining innovation and as blue or red ocean, using company documents and financial performance.
The document discusses capital structure and its components. It defines capitalization as the total amount of securities issued by a company, including equity share capital, preference share capital, long-term loans, retained earnings, and capital surplus. Capital structure refers to the proportion of different types of securities that make up the total capitalization. Financial structure includes all financial resources, both short-term and long-term, including current liabilities. The document then discusses various theories of capital structure, including the net income approach, net operating income approach, and traditional approach. It provides examples to illustrate how these approaches analyze the impact of leverage on firm value and cost of capital.
The document discusses theories around a company's optimal capital structure, including Modigliani-Miller's propositions that in a world without taxes or bankruptcy risk, a company's value and cost of capital do not depend on its debt-to-equity ratio. It also examines how the introduction of taxes can increase firm value through interest tax deductions, but higher debt also increases bankruptcy risk which reduces value. The optimal capital structure balances the tax benefits of debt against the costs of financial distress from taking on too much debt.
This document summarizes capital structure decisions and theories. It discusses how debt can impact a firm's weighted average cost of capital (WACC) and free cash flow (FCF). The key effects are:
- Debt can lower WACC by reducing the tax burden but increase it by raising financial risk.
- Debt can boost or reduce FCF by lowering costs through interest tax deductions but increasing bankruptcy risk.
- Capital structure theories like MM and trade-off theory examine the optimal debt-equity mix that balances these costs and benefits. Signaling theory notes managers' private information impacts financing choices.
This document provides an overview of capital structure decisions and theory. It defines key terms related to capital structure and costs of capital. It discusses how debt can impact the weighted average cost of capital and free cash flows. Capital structure theories covered include Modigliani-Miller with no taxes, corporate taxes, and corporate and personal taxes. The trade-off theory and signaling theory are also introduced.
Fm11 ch 16 capital structure decisions the basicsNhu Tuyet Tran
This document provides an overview of capital structure decisions and theory. It defines key terms related to capital structure and costs of capital. It discusses how debt can impact the weighted average cost of capital and free cash flows. Capital structure theories covered include Modigliani-Miller with no taxes, corporate taxes, and corporate and personal taxes. The trade-off theory and signaling theory are also introduced.
This document discusses financial leverage and operating leverage. It defines key terms like capital structure, financial leverage, operating leverage, and measures of leverage. It explains how financial leverage can magnify returns for shareholders but also increases risk. The combination of financial and operating leverage further impacts earnings per share. The document also distinguishes between operating risk, which depends on variability of sales and expenses, and financial risk, which results from the use of debt.
This document discusses capital structure and the limits of using debt. It introduces the concept that a firm's value is the sum of its debt and equity values. While increasing leverage can increase firm value by taking advantage of tax benefits, it also increases financial distress costs. There is an optimal capital structure that balances these factors. The document also discusses how signaling and agency costs further complicate determining the optimal structure.
1) The document discusses corporate financing and valuation, specifically the trade-off theory of capital structure.
2) The trade-off theory states that a company's optimal capital structure balances the benefits of interest tax shields from debt financing against the costs of financial distress.
3) It suggests that firm value is maximized at a certain debt level that equalizes the marginal benefit of tax shields and marginal cost of financial distress.
The document discusses capital structure determination and the total value principle from Modigliani and Miller. It examines different theories of capital structure, including the net operating income approach where the weighted average cost of capital remains constant, and the traditional approach where an optimal capital structure exists that minimizes costs. Market imperfections like taxes, bankruptcy costs, and agency costs are also discussed. Arbitrage is used to show how under certain assumptions, the total value of a firm is unaffected by its capital structure.
This document provides an overview of capital structure decisions and theories. It discusses how debt can impact a firm's weighted average cost of capital, free cash flows, and risk. Capital structure theories covered include Modigliani-Miller under different tax assumptions, trade-off theory, and signaling theory. Examples are provided to illustrate how leverage can increase returns but also financial risk for stockholders.
This presentation is an overview of Capital Structure Theories.
Dr. Soheli Ghose ( Ph.D (University of Calcutta), M.Phil, M.Com, M.B.A., NET (JRF), B. Ed).
Assistant Professor, Department of Commerce,St. Xavier's College, Kolkata.
Guest Faculty, M.B.A. Finance, University of Calcutta, Kolkata
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This document discusses Mark Heath's assignment on corporate finance. It analyzes Modigliani and Miller's theories on capital structure and firm valuation. Specifically:
1) It applies their proposition I that firm value is unaffected by capital structure in a world without taxes to calculate the value of an unlevered and levered firm.
2) It discusses their proposition II that the weighted average cost of capital is also unaffected by capital structure when there are no taxes or transaction costs.
3) It examines how the introduction of corporate and personal taxes impacts firm valuation and the relationship between debt ratios and weighted average cost of capital. Bankruptcy costs are also considered in determining an optimal capital structure.
This document provides an outline and overview of capital structure and term structure theories. It discusses key concepts related to a firm's capital structure decision, including the net income approach, traditional views, Modigliani-Miller propositions, and theories such as trade-off, agency costs, and pecking order. It also covers term structure theories, including the expectations theory, segmented markets theory, and liquidity premium theory. The document uses examples and diagrams to illustrate how financial leverage, taxes, and bankruptcy costs impact a firm's optimal capital structure and cost of capital.
Financial leverage involves using debt to finance a firm's assets in order to increase expected earnings per share. While it increases expected returns, it also increases risk. There is no unique optimal capital structure, as changing leverage simply redistributes risk between shareholders and bondholders without changing firm value. According to the Modigliano-Miller propositions, capital structure is irrelevant in perfect markets with no taxes or bankruptcy costs.
The document provides financial information about Zip Zap Zoom Car Company over several years. It discusses the company's need to invest in upgrading technology and facilities to compete with increasing competition. It presents two views on determining the company's additional debt capacity. Mr. Shortsighted assumes a maximum 10% reduction in sales and 6% reduction in prices during a recession, and calculates the company can service Rs. 100 crore of additional debt. Mr. Longsighted argues a more probabilistic analysis of cash flows is needed that accounts for dividend payments and continued R&D/marketing spending. His analysis finds the company can service an additional Rs. 35 crore of debt while maintaining a 10% dividend with 95% certainty of adequate
This document summarizes key concepts regarding capital structure analysis:
1) EBIT/EPS analysis examines how different capital structures affect earnings available to shareholders and risk based on different levels of EBIT. Leverage increases EPS at high EBIT levels but decreases it at low levels.
2) Debt provides a tax shield benefit as interest payments reduce taxable income. This increases overall returns to investors compared to an unlevered firm.
3) There is a trade-off between the tax benefits of debt and the financial distress and agency costs of debt as leverage increases. Optimal capital structure balances these factors.
4) Practical considerations like industry standards, creditor requirements, maintaining borrowing capacity, and manager
The document discusses capital structure and leverage. It defines capital structure and discusses questions to consider when making financing decisions, such as determining the optimal financing mix. Appropriate capital structures should have features like profitability, solvency, flexibility, capacity, and control. Capital structure is determined by factors like taxes, flexibility, industry norms, and investor requirements. Firms can use different forms of capital structure involving various proportions of equity, debt, and preference shares. Financial leverage refers to using debt financing to magnify returns, and it can be measured using ratios like debt ratio and interest coverage. Capital structure theories address whether firm value depends on capital structure.
Capital structure decisions impact firm value. While the Modigliani-Miller theories concluded capital structure is irrelevant in perfect markets, other theories recognize costs like bankruptcy and agency costs. An optimal capital structure balances tax benefits of debt against these costs. Managers should consider their firm's risk level and investment opportunities to determine an appropriate capital structure.
The document discusses capital structure and various theories related to it. It defines capital structure as the combination of capital from different sources of financing. It then discusses factors that affect capital structure decisions like control, risk, cost, size and nature of business. It explains optimal capital structure as the perfect mix of debt and equity that maximizes firm value while minimizing cost of capital. It also discusses various methods of analyzing optimal capital structure including EBIT-EPS analysis and indifference point analysis. Finally, it summarizes different theories around capital structure like net income, net operating income, traditional and Modigliani-Miller approaches.
1. Read the information on the STREAMING VIDEO INDUSTRY and apply .docxjeremylockett77
This document provides instructions for analyzing three different cases related to industries and companies.
1. It asks the reader to analyze the streaming video industry using PESTEL, Porter, and strategic group analyses and discuss macroenvironmental factors impacting growth.
2. It asks the reader to analyze how the coronavirus impacts industry forces for two industries using macroenvironmental and industry analyses.
3. It asks the reader to interpret Tesla's strategy as disruptive or sustaining innovation and as blue or red ocean, using company documents and financial performance.
The document discusses capital structure and its components. It defines capitalization as the total amount of securities issued by a company, including equity share capital, preference share capital, long-term loans, retained earnings, and capital surplus. Capital structure refers to the proportion of different types of securities that make up the total capitalization. Financial structure includes all financial resources, both short-term and long-term, including current liabilities. The document then discusses various theories of capital structure, including the net income approach, net operating income approach, and traditional approach. It provides examples to illustrate how these approaches analyze the impact of leverage on firm value and cost of capital.
The document discusses theories around a company's optimal capital structure, including Modigliani-Miller's propositions that in a world without taxes or bankruptcy risk, a company's value and cost of capital do not depend on its debt-to-equity ratio. It also examines how the introduction of taxes can increase firm value through interest tax deductions, but higher debt also increases bankruptcy risk which reduces value. The optimal capital structure balances the tax benefits of debt against the costs of financial distress from taking on too much debt.
This document summarizes capital structure decisions and theories. It discusses how debt can impact a firm's weighted average cost of capital (WACC) and free cash flow (FCF). The key effects are:
- Debt can lower WACC by reducing the tax burden but increase it by raising financial risk.
- Debt can boost or reduce FCF by lowering costs through interest tax deductions but increasing bankruptcy risk.
- Capital structure theories like MM and trade-off theory examine the optimal debt-equity mix that balances these costs and benefits. Signaling theory notes managers' private information impacts financing choices.
This document provides an overview of capital structure decisions and theory. It defines key terms related to capital structure and costs of capital. It discusses how debt can impact the weighted average cost of capital and free cash flows. Capital structure theories covered include Modigliani-Miller with no taxes, corporate taxes, and corporate and personal taxes. The trade-off theory and signaling theory are also introduced.
Fm11 ch 16 capital structure decisions the basicsNhu Tuyet Tran
This document provides an overview of capital structure decisions and theory. It defines key terms related to capital structure and costs of capital. It discusses how debt can impact the weighted average cost of capital and free cash flows. Capital structure theories covered include Modigliani-Miller with no taxes, corporate taxes, and corporate and personal taxes. The trade-off theory and signaling theory are also introduced.
This document discusses financial leverage and operating leverage. It defines key terms like capital structure, financial leverage, operating leverage, and measures of leverage. It explains how financial leverage can magnify returns for shareholders but also increases risk. The combination of financial and operating leverage further impacts earnings per share. The document also distinguishes between operating risk, which depends on variability of sales and expenses, and financial risk, which results from the use of debt.
This document discusses capital structure and the limits of using debt. It introduces the concept that a firm's value is the sum of its debt and equity values. While increasing leverage can increase firm value by taking advantage of tax benefits, it also increases financial distress costs. There is an optimal capital structure that balances these factors. The document also discusses how signaling and agency costs further complicate determining the optimal structure.
1) The document discusses corporate financing and valuation, specifically the trade-off theory of capital structure.
2) The trade-off theory states that a company's optimal capital structure balances the benefits of interest tax shields from debt financing against the costs of financial distress.
3) It suggests that firm value is maximized at a certain debt level that equalizes the marginal benefit of tax shields and marginal cost of financial distress.
The document discusses capital structure determination and the total value principle from Modigliani and Miller. It examines different theories of capital structure, including the net operating income approach where the weighted average cost of capital remains constant, and the traditional approach where an optimal capital structure exists that minimizes costs. Market imperfections like taxes, bankruptcy costs, and agency costs are also discussed. Arbitrage is used to show how under certain assumptions, the total value of a firm is unaffected by its capital structure.
This document provides an overview of capital structure decisions and theories. It discusses how debt can impact a firm's weighted average cost of capital, free cash flows, and risk. Capital structure theories covered include Modigliani-Miller under different tax assumptions, trade-off theory, and signaling theory. Examples are provided to illustrate how leverage can increase returns but also financial risk for stockholders.
This presentation is an overview of Capital Structure Theories.
Dr. Soheli Ghose ( Ph.D (University of Calcutta), M.Phil, M.Com, M.B.A., NET (JRF), B. Ed).
Assistant Professor, Department of Commerce,St. Xavier's College, Kolkata.
Guest Faculty, M.B.A. Finance, University of Calcutta, Kolkata
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2. Debt-equity Mix and the
Value of the Firm
Capital structure theories:
Net operating income (NOI) approach.
Traditional approach and Net income (NI)
approach.
MM hypothesis with and without corporate tax.
Miller’s hypothesis with corporate and personal
taxes.
Trade-off theory: costs and benefits of leverage.
2
3. Net Income (NI) Approach
According to NI approach
both the cost of debt and the
cost of equity are
independent of the capital
structure; they remain
constant regardless of how
much debt the firm uses. As
a result, the overall cost of
capital declines and the firm
value increases with debt.
This approach has no basis
in reality; the optimum
capital structure would be
100 per cent debt financing
under NI approach.
ke
ko
kd
Debt
Cost
kd
ke, ko
3
4. Net Operating Income (NOI) Approach
According to NOI
approach the value of the
firm and the weighted
average cost of capital are
independent of the firm’s
capital structure. In the
absence of taxes, an
individual holding all the
debt and equity securities
will receive the same cash
flows regardless of the
capital structure and
therefore, value of the
company is the same.
ke
ko
kd
Debt
Cost
4
5. Traditional Approach
The traditional approach
argues that moderate degree
of debt can lower the firm’s
overall cost of capital and
thereby, increase the firm
value. The initial increase in
the cost of equity is more than
offset by the lower cost of
debt. But as debt increases,
shareholders perceive higher
risk and the cost of equity
rises until a point is reached at
which the advantage of lower
cost of debt is more than offset
by more expensive equity.
ke
ko
kd
Debt
Cost
5
6. MM Approach Without Tax:
Proposition I
MM’s Proposition I states
that the firm’s value is
independent of its capital
structure. With personal
leverage, shareholders can
receive exactly the same
return, with the same risk,
from a levered firm and an
unlevered firm. Thus, they
will sell shares of the over-
priced firm and buy shares
of the under-priced firm
until the two values
equate. This is called
arbitrage.
ko
Debt
Cost
MM's Proposition I
6
7. Arbitrage
7
Levered Firm ( ):
60,000 50,000 110,000
interest rate 6%; NOI 10,000
shares held by an investor in 10%
Unlevered Firm ( ):
100,000
NOI 10,000
l l l
d
l
u u
L
V S D
k X
L
U
V S
X
8. Arbitrage
8
Return from Levered Firm:
10 110,000 50 000 10% 60,000 6 000
10% 10,000 6% 50,000 1,000 300 700
Alternate Strategy:
1. Sell shares in : 10% 60,000 6,000
2. Borrow (personal leverage):
Investment % , ,
Return
L
10% 50,000 5,000
3. Buy shares in : 10% 100,000 10,000
Return from Alternate Strategy:
10,000
10% 10,000 1,000
: Interest on personal borrowing 6% 5,000 300
Net return 1,000 300 700
Ca
U
Investment
Return
Less
sh available 11,000 10,000 1,000
9. MM’s Proposition II
The cost of equity for a
levered firm equals the
constant overall cost of
capital plus a risk premium
that equals the spread
between the overall cost of
capital and the cost of debt
multiplied by the firm’s
debt-equity ratio. For
financial leverage to be
irrelevant, the overall cost of
capital must remain constant,
regardless of the amount of
debt employed. This implies
that the cost of equity must
rise as financial risk
increases.
ke
ko
kd
Debt
Cost
MM's Proposition II
9