BU393 Study Guide - Quiz Guide: Operating Leverage, Tax Shield, Capital Structure
Document Summary
Capital structures & limits to the use of debt. Capital structure the proportion of debt and equity financing which a firm chooses to optimize its value. The optimal capital structure is one that minimizes a firm"s cost of capital. Determining a firm"s financial structure means answering two basic questions: Long term sources of a firm"s capital structure include: When there is a significant probability of bankruptcy: Can be measured by standard deviation of ebit. Operating leverage arises from fixed cost associated with production. Financial leverage arises from the amount of debt in a firm. Degree of operating leverage (dol) measures impact of change in sales on ebit. Degree of financial leverage (dfl) measures impact of change in operating income on earnings available to common shareholders. Net income = (ebit interest) x (1 tax rate) The entirely equity financed, or of the investment can be funded by a 10 year bank loan at 8%.
