ECON 3430 Chapter Notes - Chapter 16: S&P 500 Index, Capital Structure, Psychomania
16 Feb 2017
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ECON 3430 Full Course Notes
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16. 1 how borrowing affect"s value in a tax-free economy. Mm"s proposition 1 or debt-irrelevance proposition the principle that the market value of a firm is unaffected by its capital structure (under the assumption that there are no taxes and perfect market exists) Instead the value for the firm depends on the value of cfs. Operating risk/business risk risk i(cid:374) a fir(cid:373)"s operati(cid:374)g i(cid:374)(cid:272)o(cid:373)e. Financial leverage debt financing amplifies the effects of changes in operating income on the returns to shareholders. A firm that uses debt is referred to as a levered firm. Although debt financing does not affect the operating risk/business risk, it does add financial risk (e. g. more likely shareholders will not get their pay since debtholders get paid first) As a result, with increased debt, equity-holders require a greater return. Mm"s proposition ii the principle that the required rate of return on equity increases as the fir(cid:373)"s de(cid:271)t-equity ratio increases.
