BUS 312 Lecture Notes - Lecture 18: Big Mistake, Capital Structure, Opportunity Cost
4 Dec 2018
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Document Summary
Modigliani-miller theorem: no combination is better than any other, modigliani-miller proposition i: the value of the firm is independent of its capital structure . No this reasoning ignores the hidden cost of debt: raising more debt makes existing equity more risky! The rate of increase depends on the spread between ra and rd . We have learnt from modigliani-miller that in a frictionless world, capital structure is irrelevant: when there are frictions, capital structure matters! Bankruptcy costs: bankruptcy costs entail direct and indirect costs, direct costs: anything involving courts and law firms cannot be free, indirect costs: high default risk distorts investment decisions (we are going to review examples) Empirical evidence: bankruptcy is potentially an expensive process. United airlines paid over million to lawyers, accountants and consultants while it was in bankruptcy. 19,000 documents filed with new york bankruptcy court: but not always, and there are economies of scale in bankruptcies.
