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2.
3.
4.
Financial Structure 5.
6.
Capital Structure 7. Why is Capital Structure Important?
8. What is the Optimal Capital Structure?
9. Independence Hypothesis
10.
Independence Hypothesis: Rix Camper Manufacturing Company 11.
Independence Hypothesis: Rix Camper Manufacturing Company 12.
Independence Hypothesis: Rix Camper Manufacturing Company 13.
Independence Hypothesis: Rix Camper Manufacturing Company k=+g= D 1 P 14.
Independence Hypothesis: Rix Camper Manufacturing Company k=+g =+0= D 1 1.00 P 10.00 15.
Independence Hypothesis: Rix Camper Manufacturing Company k=+g =+0=10% D 1 1.00 P 10.00 16.
Independence Hypothesis: Rix Camper Manufacturing Company 17.
Independence Hypothesis: Rix Camper Manufacturing Company 18.
Independence Hypothesis: Rix Camper Manufacturing Company 19.
Independence Hypothesis: Rix Camper Manufacturing Company 20.
Independence Hypothesis: Rix Camper Manufacturing Company k=+g = D 1 P 21.
Independence Hypothesis: Rix Camper Manufacturing Company k=+g =+0=D 1 1.267 P 10.00 22.
Independence Hypothesis: Rix Camper Manufacturing Company k=+g =+0=12.67% D 1 1.267 P 10.00 23.
Independence Hypothesis: Rix Camper Manufacturing Company 24.
Independence Hypothesis: Rix Camper Manufacturing Company 25.
Independence Hypothesis: Rix Camper Manufacturing Company 26.
Independence Hypothesis: Rix Camper Manufacturing Company 27.
Independence Hypothesis: Rix Camper Manufacturing Company 28.
Independence Hypothesis: Rix Camper Manufacturing Company 29. Independence Hypothesis Cost of Capital kc 0% debtFinancial Leverage100% debt . kc = cost of equity kd = cost of debt ko = cost of capital 30. Independence Hypothesis . Cost of Capital kc kd kd 0% debtFinancial Leverage100% debt 31. Independence Hypothesis . Cost of Capital kc kd kd 0% debtFinancial Leverage100% debt 32. Independence Hypothesis Increasing leverage causes the cost of equity to rise. Cost of Capital kc kd kd 0% debtFinancial Leverage100% debt 33. Independence Hypothesis Cost of Capital kc kd kc kd Increasing leverage causes the cost of equity to rise. 0% debtFinancial Leverage100% debt 34. Independence Hypothesis Cost of Capital kc kd kc kd Increasing leverage causes the cost of equity to rise. What willbe the net effect on the overall costof capital?0% debtFinancial Leverage100% debt 35. Independence Hypothesis Cost of Capital kc kd kc kd Increasing leverage causes the cost of equity to rise. What willbe the net effect on the overall costof capital?0% debtFinancial Leverage100% debt 36. Independence Hypothesis kc kd Cost of Capital kc ko kd 0% debtFinancial Leverage100% debt 37.
Independence Hypothesis 38. Dependence Hypothesis
39. Dependence Hypothesis Since the cost of debt is lower than the cost of equity... Cost of Capital kc kd Financial Leverage kc kd 40. Dependence Hypothesis Since the cost of debt is lower than the cost of equity increasing leverage reduces the cost of capital. Cost of Capital kc kd Financial Leverage kc kd ko 41. Moderate Position
42.
Rix Camper example: Tax effects of financing with debt 43. Moderate Position Cost of Capital kc kd Financial Leverage kc kd 44. Moderate Position Cost of Capital kc kd Financial Leverage kc kd Even if the cost of equity rises as leverage increases, thecost of debtisvery low... 45. Moderate Position Cost of Capital kc kd Financial Leverage kc kd because of thetax benefit associated with debt financing. Even if the cost of equity rises as leverage increases, thecost of debtisvery low... 46. Moderate Position Cost of Capital kc kd Financial Leverage kc kd The low cost of debtreduces the cost ofcapital. 47. Moderate Position Cost of Capital kc kd Financial Leverage kc kd The low cost of debtreduces the cost ofcapital. ko 48. Moderate Position
49. Why is 100% Debt Not Optimal?
50.
Why is 100% Debt Not Optimal? 51. Moderate Position with Bankruptcy and Agency Costs Cost of Capital Financial Leverage kc kd 52. Moderate Position with Bankruptcy and Agency Costs Cost of Capital Financial Leverage kc kd kd 53. Moderate Position with Bankruptcy and Agency Costs Cost of Capital Financial Leverage kc kd kd 54. Moderate Position with Bankruptcy and Agency Costs Cost of Capital Financial Leverage kc kd kc kd 55. Moderate Position with Bankruptcy and Agency Costs Cost of Capital Financial Leverage kc kd kc kd 56. Moderate Position with Bankruptcy and Agency Costs Cost of Capital Financial Leverage kc kd kc kd If a firm borrows too much, the costs of debt and equity will spikeupward, due to bankruptcy costs and agency costs. 57. Moderate Position with Bankruptcy and Agency Costs Cost of Capital Financial Leverage kc kd kc kd 58. Moderate Position with Bankruptcy and Agency Costs Cost of Capital Financial Leverage kc kd kc kd ko 59. Moderate Position with Bankruptcy and Agency Costs Cost of Capital Financial Leverage kc kd kc kd ko 60. Moderate Position with Bankruptcy and Agency Costs Cost of Capital Financial Leverage kc kd kc kd ko Ideally, a firm should use leverage to obtain their optimum capitalstructure, which will minimize the firms cost of capital. 61. Moderate Position with Bankruptcy and Agency Costs Cost of Capital Financial Leverage kc kd kc kd ko 62. Capital Structure Management
63. Capital Structure Management
EPS=(EBIT - I)(1 - t) - P S 64. Capital Structure Management
EPS=(EBIT - I)(1 - t) - P S I = interest expense, P = preferred dividends, S = number of shares of common stockoutstanding. 65. EBIT-EPS Example
66. If we expect EBIT to be $2,000,000:
67.
If we expect EBIT to be $4,000,000: 68.
69. If we choose stock financing: EPS EBIT $1m$2m$3m$4m stockfinancing 0 3 2 1 70. If we choosebond financing: EPS EBIT $1m$2m$3m$4m bondfinancing 0 3 2 1 71. Breakeven EBIT EPS EBIT $1m$2m$3m$4m bondfinancing stockfinancing 0 3 2 1 72. Breakeven Point
73. Breakeven Point
74. Breakeven Point
75. Breakeven EBIT EPS EBIT $1m$2m$3m$4m bondfinancing stockfinancing 0 3 2 1 For EBIT up to $3 million, stockfinancing is best. 76. Breakeven EBIT For EBIT up to $3 million, stock financing is best. For EBIT greater than $3 million,debtfinancing is best. EPS EBIT $1m$2m$3m$4m bondfinancing stockfinancing 0 3 2 1 77. In-class Problem
78. Breakeven EBIT
79. Analytical Income Statement
80. Breakeven EBIT leveredfinancing stockfinancing EPS EBIT $.5m$1m$1.5m$2m 0 .65 .45 .25 81. Breakeven EBIT For EBIT up to $1.08 m, stock financing is best. leveredfinancing stockfinancing EPS EBIT $.5m$1m$1.5m$2m 0 .65 .45 .25 82. Breakeven EBIT For EBIT up to $1.08 m, stock financing is best. For EBIT greater than $1.08 m,the levered plan is best. leveredfinancing stockfinancing EPS EBIT $.5m$1m$1.5m$2m 0 .65 .45 .25 83. In-class Problem
84. Breakeven EBIT
85. Analytical Income Statement
86. Breakeven EBIT leveredfinancing stockfinancing EPS EBIT $1m$2m$3m$4m 0 1.5 1.17 .5 87. Breakeven EBIT leveredfinancing stockfinancing For EBIT up to $2.16 m, stock financing is best. EPS EBIT $1m$2m$3m$4m 0 1.5 1.17 .5 88. Breakeven EBIT leveredfinancing stockfinancing For EBIT greater than $2.16 m,the levered plan is best. For EBIT up to $2.16 m, stock financingis best. EPS EBIT $1m$2m$3m$4m 0 1.5 1.17 .5