Topic 11- Financing Analysis: Capital Structure Flashcards
Is debt or equity paid first?
debt
Debt is the promise of
fixed payments in the future
What happens if debt payments aren’t made?
shareholders can lose control of the firm
for debt interest is
tax deductible
low or high priority for debt in financial trouble?
high
low or high priority for equity in financial trouble?
low
debt does or doesn’t have management control
doesn’t
2 examples of debt
bank debt, bonds
equity is when equity holders
get (or reinvest) the leftover CFs after debt payments are made
equity is what type of claim?
residual
dividends are or aren’t tax deductible
aren’t
life of equity vs debt
equity inf, debt fixed
equity does or doesn’t have management control
does
2 examples of equity
owner’s equity (in a limited partnership) or common shares (corporate)
3 advantages of debt
- tax benefit
- disciple
- incentives to managers to increase CFs of the firm
Tax benefit is when
int expenses on debt are tax deductible
CFs for equity aren’t
tax deductible
increase in tax rate decreases or increases tax benefit
increase
for disciple borrowing forces
managers to be careful and not invest stupidly
an increase in separation between managers and stockholders creates an increase in
tax benefit
3 disadvantages of debt
- insolvency costs
- agency costs
- loss of flexibility
insolvency costs are due to
an increase in debt meaning an increase in the likelihood of NOT being able to make debt payments
bankruptcy costs formula
E(b)= prob(going bankrupt) x cost (going bankrupt)
with more volatile earnings comes an increase in
the porb of going bankrupt
