Introduction a Financing decisions become irrelevant as long as equity holders are happy with their returns a firm can be highly levered yet no one is concerned as long as dividends are acceptable Problems arise when returns arent enough to cover debt commitments and dividends cease
Introduction ◼ Financing decisions become irrelevant as long as equity holders are happy with their returns. ◼ A firm can be highly levered yet no one is concerned as long as dividends are acceptable. ◼ Problems arise when returns aren’t enough to cover debt commitments and dividends cease
Capital Structure Dilemma does the manner in which investment proposals are financed matter? If SO what is the optimal capital structure? a Does varying the capital structure affect share price? If So, which financing policy maximises share price? How is a choice between alternative financing options made? Which option maximises shareholders' wealth?
Capital Structure Dilemma ◼ Does the manner in which investment proposals are financed matter? If so, what is the optimal capital structure? ◼ Does varying the capital structure affect share price? If so, which financing policy maximises share price? ◼ How is a choice between alternative financing options made? Which option maximises shareholders’ wealth?
Traditional Approach The RELEVANCE ARGUMENT capital structure is relevant to the market value of the firm and the firm's cost of capital a There is an optimal debt-to-equity mix that minimises wacc and maximises the market value of the firm to its shareholders
Traditional Approach ◼ The RELEVANCE ARGUMENT - capital structure is relevant to the market value of the firm and the firm’s cost of capital. ◼ There is an optimal debt-to-equity mix that minimises WACC and maximises the market value of the firm to its shareholders
Traditional Approach aa company is able to increase its total market value and decrease its wacc by the use of moderate amounts of debt There is an optimal level of debt and an optimal capital structure
Traditional Approach ◼ A company is able to increase its total market value and decrease its WACC by the use of moderate amounts of debt. ◼ There is an optimal level of debt and an optimal capital structure
Traditional Approach k k OCS D:E Ratio
Traditional Approach k OCS D:E Ratio ks k kd