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Chapter 13
Principles of Capital Structure
Copyright 2005 McGraw-Hill Australia Pty Ltd
PPTs t/a Business Finance by Peirson, Brown, Easton, Howard and Pinder 13–1
Prepared by Dr Buly Cardak
Learning Objectives
• Explain the effects of financial leverage.
• Distinguish between business risk and financial risk.
• Understand the ‘capital structure irrelevance’ theory of Modigliani and Miller (MM).
• Explain the roles of taxes and other factors that may influence capital structure decisions.
Copyright 2005 McGraw-Hill Australia Pty Ltd
PPTs t/a Business Finance by Peirson, Brown, Easton, Howard and Pinder 13–2
Prepared by Dr Buly Cardak
Learning Objectives (cont.)
• Understand the concept of an optimal capital structure, based on a trade-off between the benefits and costs of using debt.
• Explain the ‘pecking order’ theory of capital structure.
• Outline Jensen’s free cash flow theory.
Copyright 2005 McGraw-Hill Australia Pty Ltd
PPTs t/a Business Finance by Peirson, Brown, Easton, Howard and Pinder 13–3
Prepared by Dr Buly Cardak
Introduction
• Capital structure
– The mix of debt and equity finance used by a company.
• Optimal capital structure
– The capital structure which maximises the value of a company.
– Does the value of the net operating cash flow stream depend on how it is divided between payments to lenders and shareholders?
Copyright 2005 McGraw-Hill Australia Pty Ltd
PPTs t/a Business Finance by Peirson, Brown, Easton, Howard and Pinder 13–4
Prepared by Dr Buly Cardak
Effects of Financial Leverage
• Business risk
– The variability of future net cash flows attributed to the nature of the company’s operations (the risk faced by shareholders if the company is financed only by equity).
• Financial risk
– The risk attributable to the use of debt as a source of finance.
Copyright 2005 McGraw-Hill Australia Pty Ltd
PPTs t/a Business Finance by Peirson, Brown, Easton, Howard and Pinder 13–5
Prepared by Dr Buly Cardak
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