10. Financial Leverage & Capital Structure Policy Flashcards
What s home-made leverage?
The use of personal borrowing to change the overall amount of financial leverage to which the individual is exposed
What is M&M proposition I?
The value of the firm is independent of its capital structure
What is M&M proposition II?
A firm’s of equity capital is a positive linear function of its capital structure
What is business risk?
The equity risk that comes from the nature of the firm’s operating activites
What is financial risk?
The equity risk that comes from the financial; policy (i.e. capital structure) of the firm
What is the interest tax shield?
The tax saving attained by a firm from interest expense
What is unleveraged cost of capital?
The cost of capital of a firm that has no debt
What are direct bankruptcy costs?
The costs that are directly associated with bankruptcy, such as legal and administrative expenses
What are indirect bankruptcy costs?
The difficulties of running a business that is experiencing financial distress
What are financial distress costs?
The direct and indirect costs associated with going bankrupt or experiencing financial distress
What is static theory of capital structure?
Theory that a firm borrows up to the point where the tax benefit from an extra dollar in debt is exactly equal to the cost that comes from the increased probability of financial distress
What is the pecking order theory?
The process of the firm choosing profits, debt and equity in this order to finance investments
What is information asymmetry cost?
This arises because investors do not have the same information as management in relation to the prospects of the firm
What are agency costs of debt?
These arise because equity holders may act in their own interest rather than the interests of the firm as a whole
What is the optimal capital structure?
The one that maximises the value of the firm and minimises the overall cost of capital
