Mod 15 Flashcards
After tax cost of debt
Cost of using debt financing net of the tax savings due to deductibility of interest expense
Bankruptcy
Legal proceeding involving a business that is unable to fulfill its contractually required debt obligations
Bankrupcy Process
Begins with a petition filed by debtor or creditors
Debtors assets are evaluated and the court decides
Which assets are liquidated
Which debts are forgiven
Which parties control the firm
Bankruptcy costs
Cost a firm incurs when it files for protection from its creditors
Lost sales, suppliers changing
terms, difficulty in retaining employees, distracted manager, legal costs
Business risk
Volatility of cash flows generated by assets
Different firms have different assets, business risk unique to a given firm/industry
Capital structure weight of debt
Faction of financing that is raised from lenders to fund assets
Capital structure weight of equity
Fraction of financing that is raised from owners to fund assets
Capital structure weights
% of money raised from each source of capital
Must sum to one to account for all financing
Cost of debt
Min required rate of return by a bondholder to provide capital to a firm ‘
Calculate yield to maturity of a firm’s bonds currently trading
Cost of equity
Min required rate of return by a shareholder to provide capital to a firm
Use CAMP
Dividends are not tax deductible
Cost of equity = after tax cost of equity
Financial distress
Firm is either close to bankruptcy or enters bankruptcy
Financial distress costs
Lost sales, suppliers changing terms, difficulty in retaining employees, distracted managers
Financial risk
Additional volatility that a manager imposes on shareholders by levering up
Magnifies existing business risk
Puts payments to bondholders in front of shareholders
Interest tax shield
Tax savings due to deductibility of interest expense
Reduce the cash flow from the firm that goes to pay the gov
Use savings to increase payments to capital providers
Leverage
Extent to which debt is used for financing
