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Lecture 7

FINA601 Lecture Notes - Lecture 7: Corporate Finance, Financial Distress, Capital Structure


Department
FINA
Course Code
FINA601
Professor
Ivan
Lecture
7

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Week 7 Lecture 7 Chapter 17: Capital Structure: Limits to the Use of Debt
Costs of Financial Distress (17.1)
Bankruptcy Risk or Bankruptcy Cost?
As mentioned throughout the previous chapter, debt provides tax benefits to the firm.
However, debt puts pressure on the firm because interest and principal payments are
obligations.
If these obligations are not met, the firm may risk some sort of financial distress.
The ultimate distress is bankruptcy, where ownership of the firm’s assets is legally
transferred from the stockholders to the bondholders. These debt obligations are
fundamentally different from stock obligations. Although stockholders like and expect
dividends, they are not legally entitled to dividends in the way bondholders are legally
entitled to interest and principal payments.
Example:

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