COMMERCE 3FA3 Lecture Notes - Lecture 6: Capital Structure, Cash Flow
16 Dec 2014
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Section 2: capital structure: introduction, cost of capital depends on relative weightings of b and s. e. g. k = kd (b/v) + ke (s/v, decision concerning weights is called capital structure decision. Capital structure: capital structure decision the weights for b and s in the cost of capital. K = kd (1-tc) (b/v) + ke (s/v) Nb: these weights will also have an impact on ke and unless debt is risk-free, on kd. The pie here is simply the value of the firm(v) that is the sum of the various claims on the firm of securities that the firm issues. V = b + s in our simple framework. The firm"s objective is to make the pie as large as possible i. e. to maximize firm value. The firm would choose a capital structure that is 50% debt over one that is 40% debt. Ordinarily, a continuum of choices would be available.
