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TTU Merriman FIN 3320- The Financing Decision Terms in this set (44) The Financing Decision long term, capital structure. Where should a company raise money to fund its projects? Finance Policy The strategy or guidelines a company follows in deciding€7,27
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TTU Merriman FIN 3320- The Financing Decision Terms in this set (44) The Financing Decision long term, capital structure. Where should a company raise money to fund its projects? Finance Policy The strategy or guidelines a company follows in deciding
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TTU Merriman FIN 3320- The Financing Decision
Terms in this set (44)
The Financing Decision long term, capital structure. Where should a company raise money to fund its projects?
Finance Policy The strategy or guidelines a company follows in deciding how much debt and equity to use for its...
TTU Merriman FIN 3320- The Financing Decision
Jeremiah
Terms in this set (44)
The Financing Decision long term, capital structure. Where should a company raise money to fund its projects?
The strategy or guidelines a company follows in deciding how much debt and equity to
Finance Policy
use for its projects
the proportion of debt and equity a company uses to finance the projects it undertakes
Capital Structure
(aka investing decision)
Debt: borrowed money that must be paid over time with interest (coupon rate is cost of
debt)
Types of financing
Equity: money given in exchange for ownership of the company (expected return is
cost of equity)
Loans: borrowing money from banks that must be paid back w/ interest
Types of Debt
Bonds: borrowing money from investors that must be paid back with interest
Owners equity (internal capital): money from current owners in the company
Types of Equity
Outside equity (external capital): money from new owners
We use leverage ratios. Most common measures are debt-to-equity and debt-to-
Measuring Capital Structure
capital
Leverage use of borrowed funds (debt) to purchase assets.
Ensures company has enough cash to invest in value enhancing projects while
Purpose of Finance Policy
minimizing cost of capital to fund those projects
Proportion of debt and equity are not relevant to value of a company, therefore capital
structure is irrelevant.
Capital Structure Irrelevance Theory
Says PROPORTION is irrelevant, not AMOUNT of debt and equity. Not a matter of how
much but where the company gets the $! Amount of money needed to fund a project is
still relevant
TTU Merriman FIN 3320- The Financing Decision
Value Irrelevance Value of company is unaffected by capital structure under ideal conditions
Cost Irrelevance Cost of capital is unaffected by capital structure under ideal conditions
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Limitations of CSIR Assumes no taxes and no bankruptcy.
Advantages include a tax shield: interest pmts on debt are tax-deductible, reducing
company's taxable income
Optimal Capital Structure: Characteristics of
debt
Disadvanages: Bankruptcy risk. Interest payments. need to be paid no matter what
(contractual payments)
Tax shield reduction of taxable income that results from taking deductions allowable by tax law
Financial distress when a company experiences difficulty in meeting financial obligations to creditors
Bankruptcy legal process designed to help businesses that are unable to repay their debts
Advantages: lower cost of debt and tax shield increases amount of debt the company
can take
Disadvantages: higher cost of equity and risk of bankruptcy decreases amount of debt
Tradeoff of Optimal Capital Structure
company can take.
Debt is CHEAPER, but RISKIER
If we____ cost of capital, the value of the minimize; maximized
company will be _____
Cost of capital schedule Table that shows costs associated with different sources and proportions of financing
Limitation of Cost of Capital Schedule It's all an estimate; we don't have actual costs
activities that alter the companies existing capital structure:
Restructuring Over levered: Company has taken too much debt relative to equity
Under levered: Company has taken too little debt relative to equity
Over levered (too much debt) Issue stock for new projects; Use cash profit from past projects to pay off existing debt
Issue new debt for projects; Use cash prpfit from past projects to repurchase existing
Under levered (too little debt)
shares
What is capital structure? E) The proportion of debt and equity a company uses to finance its operations
A) The mix of short-term and long-term debt
B) The company's investment policy
C) The method used to calculate the cost of
capital
D) The distribution of profits to shareholders
E) The proportion of debt and equity a
company uses to finance its operations
What is the primary goal of the financing B) Minimize the cost of capital to maximize the value of the business
decision in corporate finance?
A) Minimize tax liabilities
B) Minimize the cost of capital to maximize
the value of the business
C) Reduce the cost of goods sold
D) Increase market share
E) Improve employee satisfaction
TTU Merriman FIN 3320- The Financing Decision
https://quizlet.com/929834591/ttu-merriman-fin-3320-the-financing-decision-flash-cards/ 2/6
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