term 2 - lecture 6- capital structure 2 Flashcards
what is the MM proposition 1?
what is the MM proposition 2?
what are the main assumptions underlying MM capital structure irrelavance results>
how can corporations utilise debt to save on taxes>
what is the MM proposition 1 with corporate taxes?
how do we measure the PV of the interest tax shield?
why is it typical that the presebt value of the tax shield is uncertain?
what is the interest tax shield each year for permanent debt that is riskless with risk free interest rate rf?
what can the tax shield for permanent riskless debt be valued as?
the tax shield for permanent riskless debt can be valued as a perpetuity
with permanent debt, what is the formula to calculate the present value of the tax shield?
how can cash flows be represented by unlevered and levered firms?
what is the MM proposition 2 with corporate taxes?
how many times are cash flows to equity investors typically taxed?
The cash flows to equity investors are typically taxed twice – once at the corporate level and then again
when they receive their dividend payments. only the cash flows after tax are what the investors consider when making investment decisions
how do personal taxes reduce the benefits of corporate tax benefits?
due to the double taxation experienced by investors. personal taxes reduce the cash flows to investors and can offset some of the corporate tax benefits of leverage
how doe sequity financing provide personal tax advantages?
capital gains and sometimes dividends are taxed at lower rates than interest income.
how can investors defer paying taxes?
interest and dividend income received by investors in the firm is taxed immediately upon receipt. capital gains are taxed only when the shares are sold, hence investors can defer paying taxes by not selling their shares. investors can time their cash flows to lower average tax rates they are paying
what does miller 1977 say about the gain from leverage>
what is one of the assumptions of the original MM model and how does leverage impact this?
the assumption of no bankruptcy is critical in the original MM model. an important consequence of leverage is the risk of bankruptcy
with perfect capital markets is the risk of bankruptcy a disadvantage of debt?
what are the direct costs of bankruptcy?
what are the indirect costs of bankruptcy?
what is the trade off theory?
a theory that states that capital structure is based on a trade off between tax savings and distress cost of debt
the theoretical optimum is reached when the present value of tax saving due to further borrowing is just offset by increases in the present value of costs of distress
what are the three key factors that determine the present value of financial distress costs
1 - the probability of financial distress
2) the magnitude of the cost after a firm is in distress varies by industry
3) the discount rate of future distress cash flows
how is the probability of finacial distress a factor in the present value of FD costs??
how does the type of industry the firm is in, impact the financial distress present value costs?
what point determines the capital strucutre
how does the target debt vary from firms?
what is the optimal leverage of a firm?
what are the potential agency cots which can occur when a firm uses high levels of debt?
how might debt reduce costs for the firm?
how might debt be used as a signal?
what is the pecking order theory
in a perfect market, does capital structure matter?
no
in a market with certain imperfections, does the capital structure matter?
