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Chapter 16

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Wilfrid Laurier University
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BU393 Chapter 16 – Capital Structure: Basic Concepts Week 8 The Capital Structure Question and the Pie Theory -Pie model – a model of the firm’s debt-equity ratio. It graphically depicts slices of “pie” that represent the value of the firm in the capital markets Maximizing Firm Value versus Maximizing Shareholder Interests -Changes in capital structure benefit the shareholders if and only if the value of the firm increases Financial Leverage and Firm Value: An Example The Choice Between Debt and Equity -A risk-averse investors will prefer an all-equity firm, while a risk-neutral investor might prefer leverage -MM Proposition I – A proposition of Modigliani and Miller (MM) stating that a firm cannot change the total value of its outstanding securities by changing its capital structure proportions. Also called an irrelevance result -The value of the levered firm is the same as the value of the unlevered firm -If levered firms are priced too high, rational investors will arbitrage by borrowing on th
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