Ch 16- Financial Leverage Flashcards
what is a recap? is it like big big vast changes?
no! it can even be small changes
what is capital restructiing
involves changing the amount of leverage a firm has without chagingin the firms assets
how can we increase leverage
by issuing debt and repurchasing outstanding shares
how do we decrease leverage
issue new shares, retiring outstanding debt
what is the primary goal o financial managers
MAXIMIZE STOCKHOLDER WEALTH
- you can do this by minimizing ther weighted average cost of capital or maxiziming firm value
- choose the cap structure that will maximize stockholder weatlh
what si the total value of the firm
value of debt + value of equity
if a firm is a growth firm, what is happening over time?
it is improving its ROE over years
So the formula of ROE is NI/equity right?
YES!
we want to grow ROE, and how can you do this,
maximize NI
minimize equity [not sure about this future yushi double check]
what is break even ebit
find ebit where eebit is the same under current and proposed scenarios- formula
EBIT breakeven/ Shares (w/o leverage) =
EBIT breakeven - interest/ (Shares w leverage)
business reisk
equity risk!!
does adding debt create vallue for a frim?
yes! it reduces equity for sure but also it is important because it can create value through interest
Prop 1 is def gonna be on the final
the vlaue of a the firm increaes by the present value of the annual interst tax shield
val of levered firm = val of an unlevered firm + pv of interest tax shield
VL = Vu + VdTc
pv of int tax shield is VdTc
Prop 2
the wacc decrease as debt: equity increases because of the govt subsidy on interest payments
AS LONG AS DEBT IS CHEAPER THAN EQUITYY
A = L + SE
We can change L + SE weights without impactin assets, so what does this mean?
that we can examine the cap structure decision separately from other activities / in isolation
Do we consider long term sources of financing or short term?
only long term cuz sohrt term financing are not included in cap structure weights
If a firm wanted to increase its D/E how can it do that?
get more debt (bonds) and buy back shares
If a firm wanted to decrease its D/E how can it do that
sell shares and pay off debt
WHAT IS THE GUIDING GOAL BEHIND CAP RESTURCTUING
maximize shareholder value or
maximize val of firm (same thing)
the value of the firm is maximized when the WACC is…
minimized!
bc WACC is the disc rate right
and disc rates and value move in opposite directions
so min WACC is max value
When does a debt equity ratio represent the optimal cap structure/target cap structure?
if it results in the lowest possible WACC (cost of capital)
HIGHER FINANCIAL LEVRAGE MEANS ___ DEBT
MORE
What does financial leverage impact and not impact?
-impacts the payoffs to shareholders
- does not impact the overall cost of capital
What is ROE
return on equity!
Net Income/TE = ROA * EM = Profit Margin * TAT * EM
EPS
Earnings/Share
NI/SHARE
hOW CAN lEVERAGE IMPACT EPS AND ROE?
- both formulas deal with net income
- more debt =more fixed interest expense = lower income
BUT ALSO, more debt means less common shares! so they have an impact
LEVERAGE AMPLIFIES HE VARIATION IN EPS AND ROE
(if there is a good year, you do A LOT better; if it is a bad year, you do a LOT WORSE)
Degree of financial leverage
Percent change EPS / Precent change in EBIT = ebit/ebit-int
DO THIS CALC 2X (once for current cap structure and one for proposed)
(Higher DFL = more debt), basically this says that EPS increases/decreases by a factor of the DFL times the percent increase or decrease in EBIT