Chapter 16: Planning the Firm's Financing Mix How do we want to finance our firm's assets? 口Debt 口 Preferred equity」 Preferred o 2002. Prentice Hall. nc
Chapter 16: Planning the Firm’s Financing Mix How do we want to finance our firm’s assets? Debt Preferred Equity © 2002, Prentice Hall, Inc
Balance sheet Current Current Assets Liabilities Debt and Fixed Preferred Assets Shareholders' Equity
Balance Sheet Current Current Assets Liabilities Debt and Fixed Preferred Assets Shareholders’ Equity
Balance sheet Current Current Assets Liabilities Debt and Fixed Preferred Assets Shareholders' Equity
Balance Sheet Current Current Assets Liabilities Debt and Fixed Preferred Assets Shareholders’ Equity
Balance sheet Current Current Assets Liabilities Debt and Financial Fixed Preferred Structure Assets Shareholders? Equity
Balance Sheet Current Current Assets Liabilities Debt and Fixed Preferred Assets Shareholders’ Equity Financial Structure
Balance sheet Current Current Assets Liabilities Debt and Fixed Preferred Assets Shareholders Equity
Balance Sheet Current Current Assets Liabilities Debt and Fixed Preferred Assets Shareholders’ Equity
Balance sheet Current Current Assets Liabilities Debt and Fixed Preferred Capital Assets Structure Shareholders? Equity
Balance Sheet Current Current Assets Liabilities Debt and Fixed Preferred Assets Shareholders’ Equity Capital Structure
Why is capital structure Important? 1)Leverage: higher financial leverage means higher returns to stockholders but higher risk due to interest payments. 2)Cost of Capital: Each source of financing has a different cost. Capital structure affects the cost of capital 3)The Optimal Capital Structure is the one that minimizes the firms cost of capital and maximizes firm value
Why is Capital Structure Important? • 1) Leverage: higher financial leverage means higher returns to stockholders, but higher risk due to interest payments. • 2) Cost of Capital: Each source of financing has a different cost. Capital structure affects the cost of capital. • 3) The Optimal Capital Structure is the one that minimizes the firm’s cost of capital and maximizes firm value
What is the Optimal capital Structure? Ina“ perfect world” environment with no taxes, no transaction costs and perfectly efficient financial markets, capital structure does not matter This is known as the Independence hypothesis: firm value is independent of capital structure
What is the Optimal Capital Structure? • In a “perfect world” environment with no taxes, no transaction costs and perfectly efficient financial markets, capital structure does not matter. • This is known as the Independence hypothesis: firm value is independent of capital structure
Independence Hypothesis Firm value does not depend on capital structure
Independence Hypothesis • Firm value does not depend on capital structure
Independence Hypothesis Cost of Capital kc= cost of equity kd= cost of debt ko= cost of capital 0%o debt financial leverage 100%debt
Cost of Capital kc 0% debt financial leverage 100%debt . kc = cost of equity kd = cost of debt ko = cost of capital Independence Hypothesis
