Chapter 17 -- Capital Structure and Value - PowerPoint PPT Presentation

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Chapter 17 -- Capital Structure and Value

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No taxes, no bankruptcy, same information sets, no transaction cost ... Cost of a loss is less with others participating. Information Problems: Agency Costs ... – PowerPoint PPT presentation

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Title: Chapter 17 -- Capital Structure and Value


1
Chapter 17 -- Capital Structure and Value
  • Overview
  • Perfect markets and capital structure irrelevance
  • Influence on capital structure
  • Information problems and capital structure
  • Other considerations
  • Empirical evidence on capital structure and value

2
Perfect markets -- Modigliani and Miller
  • No taxes, no bankruptcy, same information sets,
    no transaction cost
  • Capital structure does not matter
  • Shareholders will adjust the companys structure
    to whatever they want

3
Taxes and Capital Structure
  • Differential tax rates
  • Personal ordinary income rate
  • What shareholders pay if they receive a dividend
  • Corporate ordinary income rate
  • What the corporation shares with the government
  • Personal capital gains rate
  • What you pay on the gain if you sell your stock

4
Taxes and Capital Structure
  • Differential tax rates within the corporation
  • May have other tax shields such as depreciation
  • May not have the income to pay taxes

5
Bankruptcy or Liquidation cost and Capital
Structure
  • Legal cost
  • Disruption cost
  • Expected bankruptcy cost and capital structure

6
Information Problems Agency Cost
  • Agency cost of debt
  • Cost borne by your debt-holders to monitor your
    actions or prospective actions
  • very low when debt is low but goes up as debt in
    increased

7
Information Problems Agency Costs
  • Agency cost of equity
  • Cost borne by shareholders to monitor your
    actions
  • High with no debt but decreases as debt increases
  • These cost decrease because
  • others (debt-holders) are monitoring, often with
    better information (monthly statements)
  • Cost of a loss is less with others participating

8
Information Problems Agency Costs
  • Look for the mixture of debt and equity that
    minimizes total agency costs

9
Information Problems Signaling
  • Management may have a better information set than
    the shareholders
  • Actions speak louder than words
  • The assumption of debt signals managements
    confidence in future cash flows
  • Issuing debt to buy back equity is a very
    positive signal

10
Other Considerations and Capital Structure Choice
  • Unequal cost of corporate borrowing and personal
    borrowing
  • This favors corporate borrowing over personal
    borrowing

11
Other Considerations and Capital Structure Choice
  • Additional liability of homemade leverage
  • Favors corporate over personal borrowing
  • You can only lose the value of your stock
    investment
  • With homemade leverage you can lose your personal
    assets
  • Restrictions on homemade leverage

12
Empirical Evidence on Capital Structure and Value
  • As theories predict, taxes, bankruptcy costs, and
    agency costs all have roles in determining
    capital structure
  • Science is not so complete that we can predict or
    prescribe the exact optimal capital structure
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