Week 5 - Capital Structure 1 Flashcards
Notations used for Equity
E or S
Notations for Debt
D or B
Difference between levered and unlevered firm
Levered firm uses Debt
What is Capital Structure
It is the combination of Debt and Equity
What is Financial Leverage
The use of debt
What is financial Risk
The risk associated with financial leverage, more leverage = greater risk
What is business risk
Possibility of a business not to make profit due to numerous factors such as sales volumes etc
What is Financial Risk
Depends on the types of securities issued , more debt = more leverage = more financial risk
When is financial leverage beneficial ?
If EBIT>Break even point = leverage is beneficial
What is home made leverage
Use of personal borrowing to alter the degree of financial leverage to which an individual is exposed
M&M 1958 assumptions
No taxes
Perfect capital markets
Proposition 1 (1958) - firm value : suggests what?
That home made leverage/ u-leverage suggests that capital structure is irrelevant in determining value of firm. VL = Vu
Proposition 2 1958 - cost of equity
Leverage increases risk and return to stockholders
M&M 1963 assumptions
All other assumptions of M&M 1958 excluding the one regarding tax
There are corporate profit taxes and interest is tax deductible
Personal tax is ignored
M&M 1963 Proposition 1 suggests
Value of levered firm is always greater than value of unlevered firm
Firm value increases as more debt is added to capital structure
