Class notes
FL02 - Capital Structure II
- Course
- Institution
FL02 - Capital Structure II
[Show more]
Seller
Follow
hayes
Reviews received
Content preview
FL02 2/10/15 Prof. Michael ShilligCAPITAL STRUCTURE II: MODIGLIANI AND MILLER/INTRO TO FINANCIAL
STATEMENTS
CAPITAL STRUCTURE
Balance sheet
o Real assets Assets claim on assets = liabilities
Cash & Inventory claim on assets = debt (loans, bonds,
notes)
Equipment & plant claim on assets = equity (common
stock)
MODIGLIANI AND MILLER
Firm value = debt value + equity value
Combination of debt & equity = capital structure
Can capital structure affect firm value?
o Traditional view
If cost of capital for debt is cheaper, and if firm chooses more
debt over equity firm value might increase?
There might be tax deductions for interest expenses
(for debt) hence cheaper
Rate of return on debt < rate of return on equity thus, firm
value may be maximised by using the right amount of debt
The more debt, the more risky and more expensive equity
Debt ranks higher than equity hence debt less risky
than equity
o Hence rate of return on debt is lower
o More debt higher risk of insolvency debt
paid out first before equity hence, chance that
equity might not be paid out if insolvent and not
enough funds
Thus, optimum capital structure where
Addition of one unit of debt increases cost of equity to
an extent (marginal cost) that offsets debt’s lower cost
(marginal benefit)
i.e. marginal cost = marginal benefit
o M&M Theorem
Irrelevance hypothesis:
In a perfect world (perfect information, zero
transaction costs), the capital structure is irrelevant.
Firm value is the same regardless of mix of debt and
equity
Look at the balance sheet:
The value of a firm’s actual assets is unaffected by who
owns them. Value is affected by changes on the left
hand side (debit, e.g. assets like property, plant,
equipment, etc.). Only claims to value are affected by
changes to right hand side.
Example
The benefits of buying summaries with Stuvia:
Guaranteed quality through customer reviews
Stuvia customers have reviewed more than 700,000 summaries. This how you know that you are buying the best documents.
Quick and easy check-out
You can quickly pay through credit card or Stuvia-credit for the summaries. There is no membership needed.
Focus on what matters
Your fellow students write the study notes themselves, which is why the documents are always reliable and up-to-date. This ensures you quickly get to the core!
Frequently asked questions
What do I get when I buy this document?
You get a PDF, available immediately after your purchase. The purchased document is accessible anytime, anywhere and indefinitely through your profile.
Satisfaction guarantee: how does it work?
Our satisfaction guarantee ensures that you always find a study document that suits you well. You fill out a form, and our customer service team takes care of the rest.
Who am I buying these notes from?
Stuvia is a marketplace, so you are not buying this document from us, but from seller hayes. Stuvia facilitates payment to the seller.
Will I be stuck with a subscription?
No, you only buy these notes for $7.07. You're not tied to anything after your purchase.
Can Stuvia be trusted?
4.6 stars on Google & Trustpilot (+1000 reviews)
67474 documents were sold in the last 30 days
Founded in 2010, the go-to place to buy study notes for 14 years now