Ch.13: Leverage & Capital Structure

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Capital Structure and Leverage Chapter 13
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Presentation transcript:

Ch.13: Leverage & Capital Structure Only pages 367-71, 385-9 Capital Structure Financial Leverage Bankruptcy

Capital Structure ratio of debt to equity without changing assets, the firm could issue bonds and buy back some stock issue stock and pay off some debt optimal or target capital structure

Financial Leverage Extent to which firm relies on debt. Example: ACE has $20,000 in assets (market and book value). Tax rate = 40%. Unleveraged, ACE would have $20,000 in equity and 2,000 shares outstanding. Leveraged, ACE would have $10,000 in debt (at 12%) and $10,000 in equity with 1,000 shares outstanding. Compare ACE under two capital structures, “Unlev” & “Lev,” in Bad & Good Economy.

Financial Leverage Example

Break -Even EBIT Recommended Practice EPS = (EBIT - interest)(1-t)/shares, t = tax rate Set EPS for lev and unlev equal and solve for EBIT Compare Figure 13.1 p. 371 Recommended Practice Self-Test Problem 13.1, p. 390 Problems on pp. 391-2: 1, 3 (answers are on p.549)

Bankruptcy Business Failure: firm has terminated with loss to creditors and owners Legal Bankruptcy: firm or creditors petition federal court, a legal proceeding for liquidation (Chapter 7 Bankruptcy) or reorganization (Chapter 11 Bankruptcy) Technical Insolvency: firm is unable to meet its financial obligations Accounting Insolvency: BV liabilities > BV assets

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