03 Financial Struckture Flashcards
What kinds of Equity are there?
- Common stock
- Preferred stock
What kinds of Debt are there?
- Subordinated debt
- Ordinary debt
- Secured debt
What are the Mezzanine finances
- Preferred Stock
- Subordinated Debt
How is the MV Debt Ratio Calculated
V_D / (V_E + V_D)
Which factors explain 27% of variation in market leverage
- Industry median leverage
- Tangibility
- Firm Size
- Market-to-book assets ratio
- Expected inflation
What does the Modigliani Miller theorem state?
Capital structure is independent of firm value in perfect capital markets
What are the assumptions of perfect capital markets?
- No taxes
- No cost of bankruptcy
- Perfect information
- No transaction cost for issuing debt and equity
- Investment decision not affected by capital structure
What is the second proposition of Modigliani Miller theorem?
- Return on equity increases in proportion to leverage
- Risk increases too
=> Effect of increased ROEE and increased equity beta cancel
How can you take tax effects into account?
Tax shield
V_L = V_U + T*D
What other risk do high debts hold
financial distress
What are the costs of financial distress?
Direct Costs:
Layers, accountants, consultants, …
Indirect Costs:
loss of business, additional working capital …
What does the trade off theory state?
Optimal capital structure balances tax-shields against costs of financial distress
What are the advantages of the trade off theory?
- Predicts moderate leverage
- Explains industry differences in capital structure
- Corresponds to management behavior
What are the disadvantages of the trade off theory?
- Some successful companies have little debt
- Relation between tax-shield and value is not empirically evident
- Empirically, tax sensitivity of capital structure seems to be too low
For what is FFO/Debt an indicator?
The Ability to repay debt form operating activities
For what is Debt/EBITDA an indicator?
Leverage ratio
For what is EBITDA/Interest expense an indicator?
The ability to pay interest expense
For what is OCF/Debt an indicator?
Ability to repay debt form operating activities
For what is FOCF/Debt an indicator?
Ability to repay debt from operating activities
For what is DCF/Debt an indicator?
Ability to repay debt from operating activities after capex and dividend payments
With which two violations of the Modigliani Miller Theorem does the Pecking-order theory deal?
- Asymmetric Information
- Transaction costs
What does the lemon market theorem state
For types of available goods:
good, bad, new and old
Only owner knows true value
Good products will not be traded (only lemons)
What does the pecking-order theory state
- Positive NPV projects are carried out if financed by retained earnings
- Positive NPV project will be carried out if financed by debt
Preference in financing sources
- Retained earnings
- Debit financing
- External equity financing
With wich violation of the Modigliani Miller Theorem does the Free Cash-Flow Theory deal?
Investment decision depends on the capital structure
Why does excess cash lead to inefficiencies?
- Overinvestment (below cost of capital) -> empire building
- > Debt reduces cash and its financial obligation pressures managers
What is the Agency problem
Managers can maximize their wealth at expense of shareholders
What does the Free Cash Flow Theory State?
Optimal capital structure minimizes total agency costs
- Agency costs resulting from monitoring to prevent bondholder expropriation
- Agency costs of external equity resulting from monitoring managerial slack
