Debt or Equity: Miller writes...
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The document discusses the evolution of thinking around corporate capital structures and optimal debt levels. It notes that early economic models assumed rational behavior and perfect markets in determining optimal capital structure. However, Miller argued that a firm's value will be independent of its capital structure even when accounting for interest tax deductibility. The paper examines how bankruptcy costs, taxes, and market equilibrium impact capital structure decisions. It also notes some of the assumptions in Miller's models, such as personal tax rates on stock and bond income.
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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;
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Next slide
Slide 3
A preview of capital structure issues
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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.
Capital Structure Theory
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.
Ch-2 Capital structure decision.pptx
The document discusses capital structure decision theory. It summarizes Modigliani-Miller's propositions that without taxes or financial distress costs, capital structure does not affect firm value. When taxes are introduced, debt provides a tax shield that increases firm value up to 100% debt. However, financial distress costs and agency costs offset this benefit, leading to an optimal capital structure balancing these factors. The trade-off theory holds that firm value peaks at a certain debt ratio based on taxes, financial distress costs, and information asymmetry considerations.
Capitalstructuredefenition 100426194038-phpapp02
The document discusses capital structure, which refers to the proportion of debt, preference shares, and equity on a company's balance sheet. It defines capital structure and optimal capital structure, which is when market value per share is maximum and cost of capital is minimum. An optimum mix of debt and equity can improve a firm's value and lower its weighted average cost of capital. The capital structure is influenced by both internal factors like financial leverage and growth, and external factors like industry norms and interest rates. Different theories on capital structure are presented, including the net income, net operating income, and Modigliani-Miller approaches. The assumptions behind each theory are also outlined.
Corporate Tax
Here are the key points regarding the relationship between tax avoidance and corporate social responsibility/ethical behavior:
- There is an ongoing debate about whether aggressive tax avoidance aligns with corporate social responsibility and ethical business conduct.
- Corporate social responsibility refers to companies taking responsibility for the social and economic impact of their operations on communities. This includes contributing to public welfare.
- Ethical business behavior refers to companies acting in accordance with generally accepted moral and professional standards of conduct.
- Tax avoidance uses legal methods and loopholes to minimize tax obligations. Tax evasion is illegal.
- Governments argue aggressive tax avoidance deprives them of revenue that could fund public services. Critics say it contradicts the spirit of contributing to society
Capital structure ppt
The document discusses capital structure and its theories. It defines capital structure as the proportion of long-term debt and equity used to finance a company's assets. A company's capital structure determines its risk and cost of capital. There are several theories on capital structure including the net income, net operating income, traditional, and Modigliani-Miller approaches. The optimal capital structure balances minimum costs and risks. Factors like tax rates, control, flexibility, and legal requirements influence a company's choice of capital structure.
Capital structure defenition
The document discusses capital structure, which refers to the proportion of debt and equity used to finance a company's assets. An optimal capital structure maximizes share price value and minimizes cost of capital. Factors that affect a company's capital structure include financial risk, growth opportunities, cash flows, and tax policies. Several theories on capital structure are presented, including the Net Income, Net Operating Income, and Modigliani-Miller approaches.
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FIN 534 Week 8 Part 2 Capital Structure DecisionsSlide 1Intro.docx
FIN 534 Week 8 Part 2 Capital Structure DecisionsSlide 1Intro.docx
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- 1. Before , academic discussion in finance was focused on : WHAT MARKET REALLY CAPITALIZED through DIV, PAT , OP or weighted combination of these? 1958 Application of tools of economics or economist’s model and assumptions Discriminating monopsony == optimal capital structure of firm Economist’s assumption are rational behavior, perfect market
- 2. In equilibrium, the market value of any firm must be independent of its capital structure. Arbitrage proof , can be found … Interest payments can be deducted from taxable corporate income The value of firm can be increased by the use of debt but stakeholders must incur increasing risks of bankruptcy and the costs, direct and indirect, of falling into that unhappy state. Balancing of these bankruptcy costs against the tax gains of debt finance gives rise to an optimal capital structure . In this paper, Miller has argued that even in a world in which interest payments are fully deductible in computing corporate income taxes, the value of firm, in equilibrium will still be independent of its capital structure.
- 7. Not end but the start of researching… THANKS