Chapter 7 - Capital Structure Flashcards
1
Q
Matching
A
- Duration
- Currency
- Pattern of cash flows
2
Q
Conditions for use of WACC
A
Requires risks of future investments to be identical to existing business:
- Business risk - industry
- Financial risk - gearing/capital structure
- Size (of investment)
3
Q
Portfolio Theory
A
- Start with undiversified investments
- Diversify to eliminate unsystematic risk
- Then only susceptible to systemic risk
- Use B factor in CAPM to give investors required return
4
Q
WACC and Gearing Theories
A
Traditional Theory
- Debt makes sense up to a point (since cheaper)
- Eventually risks incraese and WACC starts to rise
- There is an optimum WACC
Modigliani + Miller (no tax)
- As debt increases, benefits exactly offset by increase in ke (higher risk)
- WACC not affected by gearing (remains constant)
Modigliani + Miller (with tax)
- Added benefit of kd - WACC falls as debt (gearing) increases
M+M Assumptions
- debt always risk free (same interest rate regardless of gearing)
- perfect market - perfect info.