...17-1 a. MM Proposition I states the relationship between leverage and firm value. Proposition I without taxes is V = EBIT/rsU. Since both EBIT and rsU are constant, firm value is also constant and capital structure is irrelevant. With corporate taxes, Proposition I becomes V = Vu + TD. Thus, firm value increases with leverage and the optimal capital structure is virtually all debt. b. MM Proposition II states the relationship between leverage and cost of equity. Without taxes, Proposition II is rsL = rsU + (rsU – rd)(1 – T)(D/S). Thus, rs increases in a precise way as leverage increases. In fact, this increase is just sufficient to offset the increased use of lower cost debt. When corporate taxes are added, Proposition II becomes Here the increase in equity costs is less than the zero-tax case, and the increasing use of lower cost debt causes the firm’s cost of capital to decrease, and again, the optimal capital structure is virtually all debt. c. The Miller model introduces personal taxes. The effect of personal taxes is, essentially, to reduce the advantage of corporate debt financing. d. Financial distress costs are incurred when a leveraged firm facing a decline in earnings is forced to take actions to avoid bankruptcy. These costs may be the result of delays in the liquidation of assets, legal fees, the effects on product quality from cutting costs, and evasive actions by suppliers and customers. e. Agency costs arise from lost efficiency and the expense...
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...------------------------------------------------- Chapter 15 Capital Structure Decisions ------------------------------------------------- ANSWERS TO END-OF-CHAPTER QUESTIONS 15-1 a. Capital structure is the manner in which a firm’s assets are financed; that is, the right-hand side of the balance sheet. Capital structure is normally expressed as the percentage of each type of capital used by the firm--debt, preferred stock, and common equity. Business risk is the risk inherent in the operations of the firm, prior to the financing decision. Thus, business risk is the uncertainty inherent in a total risk sense, future operating income, or earnings before interest and taxes (EBIT). Business risk is caused by many factors. Two of the most important are sales variability and operating leverage. Financial risk is the risk added by the use of debt financing. Debt financing increases the variability of earnings before taxes (but after interest); thus, along with business risk, it contributes to the uncertainty of net income and earnings per share. Business risk plus financial risk equals total corporate risk. b. Operating leverage is the extent to which fixed costs are used in a firm’s operations. If a high percentage of a firm’s total costs are fixed costs, then the firm is said to have a high degree of operating leverage. Operating leverage is a measure of one element of business risk, but does not include the second major element...
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...with the core corporate finance functions in an applied setting. The participants are exposed to real world corporate finance decisions to be taken up by managers for creating value. Such an exposure is accomplished through a mix of theory and practice. The pedagogy employed reflects a judicious mix of case discussions, lectures and problem solving approach. COURSE OBJECTIVES The objective is to familiarize participants with the three major decision areas of Corporate Finance, viz. the investments, financing and earnings distribution decisions. Subsequently the participants are to be offered an integrated view of the decision areas by discussing the issues in corporate valuations and risk management. The course aims at sharpening the financial decision making skills of the participants. EXPECTED LEARNING OUTCOMES AND ASSOCIATED MEASURES At the end of the course student is expected to accomplish the following learning outcomes. Alignment of Course Learning Outcomes (CLOs) with the Programme Learning Goals & Objectives and Assessment of the learning outcomes of the course is presented below: Course Learning Outcomes Have fundamental understanding of corporate finance, and apply skills in corporate financial decision making in the three major decision areas, viz. the investments, financing and earnings distribution decisions Program Level...
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...The valuation effects of long-term changes in capital structure ABSTRACT The objective of this study is to analyze and examine the changes in capital structure that do not affect the value of the firm and we have to know the relationship between the capital structure and the firm’s value. We are try to learn the changes in capital structure that do not affected the firm’s value and want to know relationship between the capital structure and the value of firm. For this study we used five independent variable that are profitability , growth , leverages , size and intangible ratio on the other hand we have one dependent variable that are firm value. We collected data from the Karachi stock exchange (KSE) and State Bank of Pakistan. Contents CHAPTER 1: INTRODUCTION 4 1.1 Background of the study 4 1.2 Problem Statement 6 1.3 Purpose of the study 7 1.4 Significance of the study 7 1.5 Operational definitions of the variables 8 1.5.1 Leverage: 8 1.5.2 Market to Book Value: 8 1.5.3 Profitability: 8 1.5.4 Growth: 8 1.5.5 Size: 8 1.5.6 Intangible: 9 CHAPTER 2: LITERATURE REVIEWS 10 2.1 Theoretical Background: 10 2.2 Empirical evidence: 11 CHAPTER 3: METHODOLOGY 17 3.1 Research Method 17 3.2 Research Model 17 3.3 Research Hypothesis: 18 3.4 Data Collection 18 3.5 Population and Sample Size 18 3.6 Research Technique 19 INTRODUCTION ...
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...Journal Of Financial And Strategic Decisions Volume 10 Number 3 Fall 1997 STRATEGIC ASSETS, CAPITAL STRUCTURE, AND FIRM PERFORMANCE Rahul Kochhar* Abstract Possession of strategic assets is a necessary condition for sustained competitive advantage. This condition is, however, not sufficient. Firms require financial management capability to realize the rents present in their strategic assets. The firm-specific nature of strategic assets implies that they be financed primarily through equity; other less specific assets should be financed through debt. Firms are likely to suffer increased costs and decreased performance if they do not adopt suitable governance structures in their transactions with potential suppliers of funds. INTRODUCTION The recently developed “resource-based view of the firm” seeks to focus the attention of researchers and managers alike on the unique and hard-to-copy strategic assets of the firm [7, 61]. Firms earn economic rents from these assets when there is an initial level of asymmetry in resource endowments, there is imperfect mobility of these assets, the market for these assets is imperfect, and competitors cannot easily obtain similar assets [2, 6, 7, 20, 24, 48]. Strategic assets provide the firm with a source of steady stream of rents so that it gains a sustained competitive advantage over its rivals. While researchers in this area have a general agreement over the characteristics of strategic assets (albeit adopting slightly different terminology...
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...Vol. 2 No. 19 [Special Issue - October 2011] Perceived Relationship between Corporate Capital Structure and Firm Value in Nigeria Semiu Babatunde ADEYEMI Department of Accounting University of Lagos Lagos, Nigeria Collins Sankay OBOH Department of Accounting University of Lagos Lagos, Nigeria Abstract This study examined the empirical effects of corporate capital structure (financial leverage) on the market value of a selection of firms listed on the Nigerian Stock Exchange. Both primary and secondary data were obtained for analysis employing both descriptive and inferential statistics for analysis. A sample size of 150 respondents and 90 firms were selected for both primary data and secondary data respectively. Descriptive statistics was used to analyse the primary data, while Chi-Square was used to draw inference of perceived relationship between capital structure and firm value. The results of the study suggested that a positively significant relationship exists between a firm’s choice of capital structure and its market value in Nigeria. The study suggested that listed firms in Nigeria should strategically plan and manage their capital structure in order to maximize their market values. Keywords: Capital structure, market value, Nigeria, debt, equity. 1. Introduction 1.1 Background to the Study After the Modigliani-Miller (1958 and 1963) paradigms on firms’ capital structure and their market values, there have been considerable debates, both in theoretical and empirical...
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...2Kashif-Ur-Rehman 1 2 Foundation University, Rawalpindi, Pakistan Iqra University Islamabad Campus, Pakistan Abstract: This study measures the relationship between organizational performance and financial management practices like capital structure decision, dividend policy, investment appraisal techniques, working capital management and financial performance assessment in Pakistani corporate sector. Sample of the study consisted of forty companies operating in Pakistan, related to different sectors and listed at Karachi Stock Exchange. The finance executives and financial analysts of the companies responded to questionnaire that identified through company profiles and references. The questionnaires were self administered to collect the data from respondents. The results show a positive and significant relationship between financial management practices and organizational performance in Pakistani corporate sector. Key words: Corporate sector % Financial management practices % Karachi stock exchange % Organizational performance INTRODUCTION The corporate sector plays a vital role in the economic outlook of any country. Financial literature suggests that capital structure has a greater impact on the economic system [1] and managers should identify the ideal corporate structure for the company [2]....
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...11/3/2008 FIN720 | Baitshepi Tebogo| 9302747|MBA | term paper | CAPITAL STRUCTURE AND DIVIDEND POLICY DISCUSSION: How does Standard Chartered Bank Botswana contribute to this discussion? | TABLE OF CONTENTS Abstract 3 Historical Background 4 Literature Review 6 Research Objectives 21 Methodology 22 Challenges 23 Methods 24 Data Analysis 25 Conclusion and Recommendations 27 References 28 Appendices 32 ABSTRACT The paper begins by highlighting the historical background of Standard Chartered Bank, and its evolution over the years, and how it eventually got to set up in business in Botswana. After this, the paper delves into the capital structure and dividend policy theories at length. The theories are at first discussed separately, and then meticulously blended as the report progresses. In addition, after a more general discussion, the topic is narrowed down to reflect on the capital structure subsisting under a banking environment. Empirical evidence from Standard Chartered Bank Botswana is then presented to assist future researchers reflect on how it stands against conventional theory. The result of the empirical study shows positive correlation between capital structure and dividend payment; and an even stronger correlation is evident between earnings per share and dividend payment. The paper, however, ends by recommending further studies using larger...
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...Alicja Nowak-Igwe ID D03509235 FI 516 Advance Managerial Finance Mini Case a) Provide a brief overview of capital structure effects. Identify the ways in which capital structure can affect the WACC and FCF. Capital structure presents how a company finance its operations. It is expressed as percentage of debt, preferred stock, common equity used in financing a company's operations.[1] WACC calculates a company's “cost of capital in which each category of capital is proportionately weighted. All capital sources - common stock, preferred stock, bonds and any other long-term debt - are included in a WACC calculation.”[2] “WACC depends on percentage of debt and common equity (wd) and (ws), the cost of debt (rd) and cost of stock (rs ) and the corporate tax rate (T)”.[3] WACC = wd(1 – T)rd + wsrs The effect of debt on WACC and Free Cash Flow is influenced by impact of the capital structure on value.[4] Capital structure affects the WACC and FCF of a company in many ways. The debt holders have a right to a cash flow before shareholders, which means that dividend can't be paid out unless all obligations toward debt holders for the specific period of time are met. Because of that, the cost of stock, rs goes up.[5] A high debt increases the risk of bankruptcy for a company, which might able to meet all payments. This risk of bankruptcy causes pre-tax cost of debt, rd, to increase.[6] In addition, increased risk of bankruptcy reduces ed free cash flow, which can be...
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...Question 1.1. (TCO A) In the United States, which of the following types of organization has the greatest revenue in total? (Points : 5) | Sole proprietorship C corporation S corporation Limited partnership | Question 2.2. (TCO A) The one thing that makes a corporation different from the other forms of business ownership is (Points : 5) | legally, the corporation is the same as its owners. it requires all owners to share liability equally. it is a legally defined entity, completely separate from its owners. it protects small shareholders, allocating most of any liability to those who own more stock. | Question 3.3. (TCO B) Which of the following would cause the present value of an annuity to increase? (Points : 5) | Reducing the number of payments. Increasing the interest rate. Decreasing the interest rate. Decreasing the liquidity of the payments. | Question 4.4. (TCO B) In a TVM calculation, if incoming cash flows are positive, outgoing cash flows must be (Points : 5) | positive. negative. either positive or negative. It really doesn’t matter. stated in time units that are different from the time units in which the interest rates are stated. | Question 5.5. (TCO G) If you were a manager of a company, which of the three right side components of the DuPont Identity would you want to increase and which would...
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...aversion to debt, CPK management is considering a debt-financed stock buyback program. The case is intended to provide an introduction to the Modigliani-Miller capital structure irrelevance propositions and the concept of debt tax shields. With the background of a pizza company, the case provides an engaging context to discuss the “pizza graphs” that are commonly used in corporate finance curriculum to illustrate the wealth effects of capital structure decisions. The case serves to motivate the following teaching objectives: • Introduce the Modigliani-Miller intuition of capital structure irrelevance; • Establish how the cost of equity is affected by capital structure decisions by defining financial risk and introducing the levered-beta capital asset pricing model (CAPM) equation; • Discuss interest tax deductibility and the valuation tax shields; • Explore the importance of debt capacity in a growing business. Suggestion for Advance Assignment to Students Students may consider the following study questions: 1. In what ways can Susan Collyns facilitate the success of CPK? 2. Using the scenarios in case Exhibit 9, what role does leverage play in affecting the return on equity (ROE) for CPK? What about the cost of capital? In assessing the effect of leverage on the cost of capital, you may assume that a firm’s CAPM beta can be modeled in the following manner: βL = βU[1 + (1 − T)D/E], where βU is the firm’s beta without leverage, T is...
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...The Application of FRICTO Analysis to Making Financing Decisions in Practice: Two Case Examples in Australia George W. Kester, Washington and Lee University Jamie Mckellar, Thiess Pty Ltd Jeremiah Mulcahy, BHP Billiton Ltd This paper describes the use of the FRICTO analytical framework for comparing financing alternatives and making financing decisions. Two case examples in Australia are presented to illustrate how two former investment bankers have used the FRICTO framework to help clients make financing decisions that take into account flexibility, risk, income, control, timing and other considerations. They have found the analytical framework prompts decision-makers to consider other important issues beyond risk and the effect on earnings per share that reflect a company’s unique and often complicated circumstances. INTRODUCTION Modigliani and Miller (1958) advanced the proposition that based upon several simplifying assumptions, capital structure has no effect on the value of a firm. However, recognizing the impact of taxes, bankruptcy, agency costs, and asymmetric information, capital structure theory has evolved to acknowledge that the use of debt does affect the value of a firm. Modern theories of capital structure can be classified into two categories: “static tradeoff models” and the “pecking order hypothesis.” Static tradeoff models imply an optimal debtequity mix which is determined by a tradeoff between the benefits and costs of debt (i.e., balancing the tax...
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...Mekelle University College of Business and Economics Department of Accounting and Finance THE DETERMINANTS OF CAPITAL STRUCTURE Evidence from Commercial Banks in Ethiopia By K i b ro m M e h a ri F i s s e h a Reg.No.-CBE/PR0025/01 Research Project Submitted to the Department of Accounting and Finance, College of Business and Economics, Mekelle University, for the partial fulfillment of the degree of Master of Finance and Investment Under the Guidance of Aregawi Gebremichael (Ph.D. Candidate) Assistant Professor May, 2010 Mekelle, Ethiopia i THE DETERMINANTS OF CAPITAL STRUCTURE Evidence from Commercial Banks in Ethiopia By Kibrom Mehari Fisseha Reg. No. CBE/PR0025/01 ii DECLARATION I, Kibrom Mehari Fisseha, hereby declare that the project work entitled “The Determinants of Capital Structure: Evidence from Commercial Banks in Ethiopia” submitted by me for the award of the degree of Master of Science in Finance and Investment of Mekelle University, is original work and it hasn’t been presented for the award of any other Degree, Diploma, Fellowship or other similar titles of any other university or institution. Place: Mekelle Signature: Date: May, 2010 ………………….. KIBROM MEHARI FISSEHA iii CERTIFICATION I certify that the project work entitled “The Determinants of Capital Structure” is a bona-fide work of Mr. Kibrom Mehari who carried out the research under my guidance. Certified further, that to the best of my...
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...CapStrMktPower I M Pandey CAPITAL STRUCTURE AND MARKET POWER I. M. Pandey Indian Institute of Management Ahmedabad Vastrapur, Ahmedabad 380015 India E-mail: impandey@iimahd.ernet.in W. P. No. 2002-03-01 March 2002 i CapStrMktPower I M Pandey CAPITAL STRUCTURE AND MARKET POWER I M Pandey ABSTRACT This paper provides new insights on the way in which the capital structure and market power and capital structure and profitability are related. We predict and show that capital structure and market power, as measured by Tobin’s Q, have a cubic relationship. That is, at lower and higher ranges of Tobin’s Q, firms employ higher debt, and reduce their debt at intermediate range. This is due to the complex interaction of the market conditions, agency problems and bankruptcy costs. We also show saucer-shaped relation between capital structure and profitability because of the interplay of agency costs, costs of external financing and debt tax shield. To our knowledge, we are the first to uncover these results. Key words: capital structure; market structure; market power; Tobin’s Q; riskshifting; moral hazard; agency problems; pecking order; trade-off theory; asset substitution. ii CapStrMktPower I M Pandey CAPITAL STRUCTURE AND MARKET POWER INTRODUCTION In corporate finance, works of Modigliani and Miller (1958; 1963) about capital structure irrelevance and tax shield advantage paved way for the development of alternative theories and a series of...
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...Chapter 13 Capital Structure and Leverage LEARNING OBJECTIVES After reading this chapter, students should be able to: • Explain why capital structure policy involves a trade-off between risk and return, and list the four primary factors that influence capital structure decisions. Distinguish between a firm’s business risk and its financial risk. Explain how operating leverage contributes to a firm’s business risk and conduct a breakeven analysis, complete with a breakeven chart. Define financial leverage and explain its effect expected EPS, and the risk borne by stockholders. on expected ROE, • • • • • Briefly explain what is meant by a firm’s optimal capital structure. Specify the effect of financial leverage on beta using the Hamada equation, and transform this equation to calculate a firm’s unlevered beta, bU. Illustrate through a graph the premiums for financial risk and business risk at different debt levels. List the assumptions under which Modigliani and Miller proved that a firm’s value is unaffected by its capital structure, then explain trade-off theory, signaling theory, and the effect of taxes and bankruptcy costs on capital structure. List a number of factors or practical considerations firms generally consider when making capital structure decisions. Briefly explain the extent that capital structure varies across industries, individual firms in each industry, and different countries. • • • • Learning Objectives: 13 - 1 LECTURE SUGGESTIONS ...
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