Chapter 17 Capital structure Determination 17-1
17-1 Chapter 17 Capital Structure Determination
Capital Structure Determination A Conceptual Look The Total-value Principle Presence of Market Imperfections and Incentive Issues The effect of taxes Taxes and Market Imperfections Combined Financial Signaling 17-2
17-2 Capital Structure Determination A Conceptual Look The Total-Value Principle Presence of Market Imperfections and Incentive Issues The Effect of Taxes Taxes and Market Imperfections Combined Financial Signaling
Capital Structure Capital Structure The mix (or proportion) of a firm's permanent long-term financing represented by debt, preferred stock, and common stock equity. Concerned with the effect of capital market decisions on security prices Assume:(1)investment and asset management decisions are held constant and (2)consider only debt-versus-equity financing 17-3
17-3 Capital Structure Concerned with the effect of capital market decisions on security prices. Assume: (1) investment and asset management decisions are held constant and (2) consider only debt-versus-equity financing. Capital Structure -- The mix (or proportion) of a firm’s permanent long-term financing represented by debt, preferred stock, and common stock equity
A Conceptual Look Relevant Rates of return ki= the yield on the company's debt Annual interest on debt B Market value of debt Assumptions Interest paid each and every year · Bond life is infinite Results in the valuation of a perpetual bond No taxes(Note: allows us to focus on just capital structure issues. 17-4
17-4 A Conceptual Look -- Relevant Rates of Return ki = the yield on the company’s debt Annual interest on debt Market value of debt I B ki = = Assumptions: • Interest paid each and every year • Bond life is infinite • Results in the valuation of a perpetual bond • No taxes (Note: allows us to focus on just capital structure issues.)
A Conceptual Look Relevant Rates of return Ke= the expected return on the company's equity Earnings available to common shareholders = e s Market value of common stock outstanding Assumptions: Earnings are not expected to grow 100%dividend payout Results in the valuation of a perpetuity Appropriate in this case for illustrating the theory of the firm 17-5
17-5 E S A Conceptual Look -- Relevant Rates of Return = = ke = the expected return on the company’s equity Earnings available to common shareholders Market value of common stock outstanding ke Assumptions: • Earnings are not expected to grow • 100% dividend payout • Results in the valuation of a perpetuity • Appropriate in this case for illustrating the theory of the firm