Capital Structure Flashcards
firm with higher operating leverage has
higher fixed costs
lower variable costs
Higher risk
More profitable when sales are HIGHER
Bond sinking fund
means to accumulate the money necessary to pay debt as it matures
More likely to be repaid at maturity (More secure)
Issuer pays lower interest rate
How to enforce a sinking fund provision
Sinking Funds are offered with Call provisions
Zero Coupon Bond
Sold at a Discount
Amortized on a Straight Line Basis
No Interest is paid
Face amount of Bond is repaid at Maturity
Financial Leverage
extent to which fixed income securities (debt and/or preferred stock) are used in a firm’s capital structure
Degree of Financial Leverage Formula
Change in Net Income/Change in EBIT
degree of operating leverage (DOL)
is a measure of the change in earnings before interest and taxes associated with a given change in sales volume
Degree of Operation Leverage Formula
Change in EBIT/Change in Revenue
Debenture Bonds
Non-Collateralized Bonds
Supported ONLY by the issuing company
Unsecured Bonds
Trade (Credit) accounts payable are measured at
the Settlement Value (undiscounted amount of cash expected to be paid to satisfy obligation)
underlying the cost of capital is primarily concerned with
New Funds and L-T funds
the cost of old funds is a sunk cost and of no relevance for decision-making purposes
Companies Ideal Capital Structure
Lowest WACC
maximizes the share price
Advantages of Commercial Paper
provides more funds at lower rate
borrower avoids the expense of maintaining a compensating balance
market provides a broad distribution for borrowing
Bond Indenture
legal document that outlines the obligations of the bond issuer
Bond Covenants
are provisions within an indenture detailing things the issuer must do (minimum ratios) or cannot do (issue additional debt without permission)
