Capital Structure In A Perfect Market Chap 14

Question 1

Capital structure

Answer 1

The relative proportions of debt, equity and other securities that a firm has outstanding

Question 2

Unlevered equity

Answer 2

Equity in the firm with no debt

Question 3

Levered equity

Answer 3

Equity in a firm with outstanding debt.
Promised payments to debt holders must be made before any payments to equity holders are distributed

Question 4

Effect of leverage on risk and return

Answer 4

Leverich increases the risk of equity, even when there is no risk that the firm will default

Question 5

MMI conditions

Answer 5

1. Investors and firms can trade at the same set of securities as competitive market prices equal to the present value of their future cash flows
2. There are no taxes, transaction cost, or insurance cost associated with security trading
3. A firms financing decision do not change the cash flows generated by its investments, nort do they reveal new information about them.

Question 6

MMI proposition

Answer 6

In a perfect capital market, the total value of a firms securities is equal to the market value of the total cash flows generated by its assets and is not affected by its choice of capital structure

Question 7

Homemade leverage

Answer 7

When investors use leverage their own portfolios to adjust the leverage choice made by a firm

Question 8

MMII proposition

Answer 8

The cost of capital of levered equity increases with the firms market value debt equity ratio

Question 9

Debt to value ratio

Answer 9

D/ E+D

Question 10

Dilution

Answer 10

An increase in the total number of shares that will divide the fixed amount of earnings. It often occurs when stocks options are exercised or a convertible bonds are converted.

Question 11

Conservation of value principle

Answer 11

With perfect capital markets, financial transactions neither add nor destroy value but instead represent repackaging of risk (and therefore return)