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Corporate Financial Management 3e
Emery Finnerty Stowe
Why Capital Structure Matters
Learning Objectives
Describe six different views of capital structure.
Describe how these views depend on the three capital market imperfections.
Explain how capital market imperfections lead to a preference ordering of financing alternatives.
Evaluate the effect of capital structure on the firm’s weighted average cost of capital.
Chapter Outline
Does Capital Structure Matter?
The Role of e Taxes
The Role of Agency Costs and Financial Distress Costs
External Financing Transaction Costs
Financial Leverage Clienteles
The Capital Market Imperfections View of Capital Structure
Capital Structure and the Principles of Finance
Incremental Benefits
Minimize the value lost to capital market imperfections (such as asymmetric taxes, asymmetric information, and transaction costs)
Capital Market Efficiency
The potential to increase firm value through capital structure is smaller than the introduction of valuable new ideas and the use of parative advantages.
Signaling
Financing transactions and capital structure changes convey information to outsiders (that may be misunderstood)
Capital Structure and the Principles of Finance
Time-Value-of-Money
Include time-value-of-money tax benefits from capital structure choices
Valuable Ideas
Securities in short supply and tax law changes can provide opportunities to create value
Behavioral
Look to information in capital structure decisions and financing transactions of other firms
Risk-Return Trade-Off
Capital structure changes made at fair-market value can change equity-debt risk bearing, but such transactions do not affect firm value
Capital Structure
Capital structure refers to how a firm is financed.
In simple terms, capital structure refers to the proportion of debt financing used by the firm.
Leverage ratio
Is firm value dependent on its choice of capital structure?
If so, how?
Perfect Market View