Chapter 16 Flashcards
Capital structure
firms mix of debt and equity
what is business risk
the risk a firms common stockholders would face if the firm had no debt
high fixed costs for a firm mean high…
operating leverage
if a firm has high operating leverage then it has _______ risk
high
when a company has a high degree of operating leverage and there is a relatively small change in sales what does this affect
large change to…
EBIT
NOPAT
return on invested capital (ROIC)
higher fixed costs are generally associated with
highly automated capital-intensive firms
a business that employs highly skilled workers
firms with high product development costs
when does the operating break-even point occur
when EBIT is equal to zero
to figure out the when the operating break even point occurs what formula do you use
EBIT=PQ-VQ-F = 0
how do you calculate incremental profits
new profit - old profit
business risk vs financial risk
business: essential to a firms operations, causes uncertainty in EBIT, NOPAT, ROIC
financial risk: if a firm uses debt, then the business risk is concentrated on common stock holders, if
what do financial and business risk combined determine
total risk of a firms future ROE
what does financial leverage magnifie
Return on Equity (ROE) - could be good or bad way
what is financial leverage
a firm issuing more debt
what do capital structure choices affect
ROE
what is the MM-Zero Tax capital structure theory and what are its assumptions
- there are no brokerage costs
- no taxes
- no bankruptcy
- investors can borrow at the same rate as corporations
- all investors have the same information
- EBIT is not affected by use of debt
is capital structure relevant in MM Zero Tax Theory
NO
what does MM Zero Taxes theory conclude
two firms producing the same cash flows must have the same value
What is MM corporate taxes theory
- corporate tax laws make it so interest from debt reduces taxes
- more CF goes to investors and less to taxes
- debt “shields” some of the firms CF from taxes
what does the MM Corporate Taxes Theory conclude
- debt adds value to the firm through the reduction of taxes
MM Corporate and Personal Taxes theory
personal taxes reduce the advantage of corporate debt
what does the MM Personal and corporate taxes theory conclude
use of debt financing remains advantageous, but benefits are less than under only corporate taxes
-firms should still use 100% debt
What is the Trade-off Theory
MM theory ignores bankruptcy costs, which increase as more debt is used
what is bankruptcy costs
the probability of financial distress
in the tradeoff theory if there is low financial leverage levels then…
tax benefits outweigh bankruptcy costs