Chapter 14 Flashcards
capital structure
The combination of debt and equity used to finance a firm.
target capital structure
The mix of debt, preferred stock, and common equity with which the firm plans to finance its investments.
business risk
The risk associated with projections of a firm’s future ROA or ROE if the firm uses no debt.
financial risk
The portion of stockholders’ risk, over and above basic business risk, resulting from the manner in which the firm is financed.
financial leverage
The extent to which fixed-income securities (debt and preferred stock) are used in a firm’s capital structure.
EPS indifference point
The level of sales at which EPS is the same whether the firm uses debt or common stock financing.
times-interest-earned (TIE) ratio
A ratio that measures the firm’s ability to meet its annual interest obligations. It is calculated by dividing EBIT by interest charges.
symmetric information
The situation in which investors and managers have identical information and managers have identical information about the firm’s prospects.
asymmetric information
The situation in which mangers have different (better) information about their firm’s prospects than do outside investors.
signal
An action taken by a firm’s management that provides clues to investors about how management views the firm’s prospects.
reserve borrowing capacity
The ability to borrow money at a reasonable cost when good investment opportunities arise. Firms often use less debt than the optimal capital structure to ensure that they can obtain debt capital later if necessary.
dividends
Distributions made to stockholders from the firm’s earnings, whether those earnings were generated in the current period or in previous periods.
dividend irrelevance theory
The theory that a firm’s dividend policy has no effect on either its value or its cost of capital.
optimal dividend policy
The dividend policy that strikes a balance between current dividends and future growth and maximizes the firm’s stock price.
dividend relevance theory
The theory that the value of a firm is affected by its dividend policy, with the optimal dividend policy being the one that maximizes the firm’s value.
information content (signaling) hypothesis
The theory that investors regard dividend changes as signals of management’s earnings forecasts.
clientele effect
The tendency of a firm to attract the type of investor who likes its dividend policy.
free cash flow hypothesis
All else being equal, firms that pay dividends from cash flows that cannot be reinvested in positive net present value projects, which are termed free cash flows, have higher values than firms that retain free cash flows.
residual dividend policy
A policy in which the dividend paid is set equal to the actual earnings minus the amount of retained earnings necessary to finance the firm’s optimal capital budget.
stable, predictable dividend policy
Payment of a specific dollar dividend each year, or periodically increasing the dividend at a constant rate; the annual dollar dividend is relatively predictable for investors.
constant payout rate
Payment of a constant percentage of earnings as dividends each year.
extra dividend
A supplemental dividend paid in ears when the firm does well and excess funds are available for distribution.
declaration date
The date on which a firm’s board of directors issues a statement declaring a dividend.
holder-of-record date (date of record)
The date on which the company opens the ownership books to determine who will receive the dividend. The stockholders of record on this date receive the dividend.
ex-dividend date
The date on which the right to the next dividend no longer accompanies a stock. It is two working days prior to the holder-of-record date.
payment date
The date on which a firm actually mails dividend checks.
dividend reinvestment plan (DRIP)
A plan that enables a stockholder to automatically reinvest dividends received back into the stock of the paying firm.
stock split
An action taken by a firm to increase the number of shares outstanding, such as doubling the number of shares outstanding by giving each stockholder two new shares for each one formerly held.
stock dividend
A dividend paid in the form of additional shares of stock rather than in cash.
