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Lecture 6

FINA601 Lecture Notes - Lecture 6: Corporate Finance, Capital Structure, Managerial Finance


Department
FINA
Course Code
FINA601
Professor
Ivan
Lecture
6

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Week 6 Lecture 6 Chapter 16: Capital Structure: Limits to the Use of Debt
Capital Structure and the Pie Theory (16.1)
How should a firm choose its debtequity ratio?
We call our approach to the capital structure question the pie model
The value of a firm is defined to be the sum of the value of the firm’s debt and the firm’s
equity
Where B is the market value of the debt and S is the market value of the equity.
Stockholder Interests
There are two important questions:
1. Why should the stockholders care about maximizing firm value? Perhaps they should
be interested in strategies that maximize shareholder value.
2. What is the ratio of debt-to-equity that maximizes the shareholder’s value?
As it turns out, changes in capital structure only benefit the stockholders if the value of the
firm increases.

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Financial Leverage, EPS, and ROE (16.2)
Consider an all-equity firm that is contemplating going into debt. (Maybe some of the
original shareholders want to cash out.)
EPS and ROE under Current and Proposed Structures

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Financial Leverage and EPS
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