ADMN 4300H Lecture Notes - Lecture 5: Capital Structure, Perfect Competition, Tax Shield
30 Mar 2020
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The capital-structure question and the pie theory: the value of a firm is defined to be the sum of the value of the firm"s debt and the firm"s equity, v = b + s. If the goal of the firm"s management is to make the firm as valuable as possible, then the firm should pick the debt-equity ratio that makes the pie as big as possible. Shareholders should care about maximizing firm value rather than strategies that maximize equity value only. Financial leverage, eps, and roe: example: an all-equity firm is considering going into debt. (maybe some of the original shareholders want to cash out. ) Eps and roe under current capital structure all equity: current shares outstanding = 400 shares. Eps and roe under proposed capital structure issue debt of ,000 and buy back 160 shares: proposed shares outstanding = 240 shares. Assumptions of the modigliani-miller model: homogeneous expectations, homogeneous business risk classes, perpetual cash flows, perfect capital markets:
