THE OPTIMAL CAPITAL STRUCTURE (cont

1

• Lesson 6
• THE OPTIMAL CAPITAL STRUCTURE (contd).
• THE USE OF LEVERAGE - LBOs

2
The choice of the optimal capital structure
Maximization of ROE
Maximization of the enterprise value
Other key-drivers (balance, flexibility,
opportunities, )
3
Maximization of shareholders return

• ROE ROI (D/E) (ROI i)
• where ROE net profit / equity
• ROI Ebit / invested capital (debt equity)
• D/E financial leverage
• i cost of debt (interest rate)

4
Relationship between ROE and ROI
Decrease self - financing
Decrease ROI
Decrease ROE
Increase cost of debt
Increase debt
ROE ROI (D/E) (ROI i)
5
Modigliani-Miller theory

• Hp in an environment where there are no taxes,
  bankruptcy risk or agency costs (no separation
  between stockholders and managers), capital
  structure is irrelevant.
• Ts the value of a firm (V) is indipendent of its
  debt ratio (D/E). The cost of capital of the firm
  will not change with leverage.

6
Modigliani-Miller theory (contd)

• The effect of taxes

V
Vl Vu Vats Vu value of unlevered firm Vl
value od levered firm Vats actual value of tax
shields
Vl
Vu
D/E
7
Trade-off theory
The effect of bankruptcy costs
Value of levered firm without bankruptcy costs
Vabc
Value of levered firm
VAts
Value of unlevered firm
Vl Vu Vats - Vabc VAcf actual value of
bankruptcy costs
8
Pecking order theory
internal
Financing sources
external
1. self-financing 2. debt 3. increase of equity
9
Financing mix decision

• 1. Macroeconomic context (capital markets)
• 2. Industry (maturity, capex, risk, etc.)
• 3. Firms characteristics (market position,
  financial-economic situation, ..)
• 4. Financial needs charact.

10
Leveraged Buyout deals

• Definition
• A leveraged buyout, or LBO, is the purchase of a
  company using a large amount of debt -- much of
  the borrowing secured by the assets of the
  company itself. Sometimes the target companys
  assets are sold to repay the loan that financed
  the takover
• Deal
• Step 1) NEWCO creation
• Step 2) NEWCO funding
• Step 3) Sellers payment
• Step 4) Merger

11
LBO - Steps