Corporate finance chapter 016 capital structure

Chapter 16: Capital
Structure

Objective
1

To understand how a firm can
create value through its
capital structure
decisions

Copyright © Prentice Hall Inc. 2000. Author: Nick Bagley, bdellaSoft, Inc.


Chapter 16 Contents
• 16.1 Internal Verses External Financing
• 16.2 Equity Financing
• 16.3 Debt Financing
• 16.4 The Irrelevance of Capital Structure in a Frictionless
Environment
• 16.5 Creating Value Through Financing Decisions
• 16.6 Reducing Costs
• 16.7 Dealing with Conflicts of Interest
• 16.8 Creating New Opportunities for Stakeholders
• 16.9 Financing Decisions in Practice
• 16.10 How to Evaluate Leveraged Investments

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Claimant Classes

Nodett

Somdett

1

Creditors

No

Yes

2

Government

Yes

Yes

3

Shareholders

Yes

Yes

3

Leverage (Gearing) Equations
CFSomdett = Net Earnings + Interest
= (EBIT - Interest) * (1 - Tax_Rate) + Interest
= EBIT * Tax_Rate + Interest * Tax_Rate
= CFNodett + Interest * Tax_Rate
Tax_Rate = 34% ⇒
CFSomdett = CFNodett + Interest * 0.34
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Market Values of Claims
Claimant

Nodett

Creditors
Shareholders
Government

Somdett

$0.0 million $40.0 million
$66.0 million $39.6 million
$34.0 million $20.4 million

Total

$100.0 million $100.0 million
5

Stock Price and Leverage
(Real Estate Project with High Bankruptcy Costs)
$100
$90
$80
Stock Price

$70
$60
$50
$40
$30
$20
$10
$0
0%

20%

40%

60%

Debt Ratio

6

80%

100%


M&M Equations
D
ke = k + (k − r )
E
E
D
WACC = ke
+r
D+E
D+E
k = the cost of equity w/out leverage
r = the risk - free rate of interest
D = market value of a firm' s debt
E = market value of the firm' s equity
V = D + E = market value of the firm
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