What is the definition of capital structure in corporate finance?
Capital structure refers to the mix of liabilities and equity that a firm uses to finance its operations and investments, which can impact profitability, risk, and overall firm value.
Capital structure — definition?
Ratio of debt and equity financing.
How does the Modigliani-Miller theorem explain the impact of capital structure on firm value in perfect markets?
The theorem states that in perfect markets, the firm's value is unaffected by its capital structure, meaning the choice between debt and equity does not influence the overall value of the firm.
WACC — role?
Minimum required return considering capital mix.
What are the key factors that influence a firm's capital structure decisions?
Key factors include business risk, financial risk, tax benefits of debt, costs of financial distress, information asymmetry, agency costs, and market conditions influencing the timing of financing.
Cost of debt — formula?
Risk-free rate + credit spread, Tax-adjusted.
Cost of equity — calculation?
CAPM: r_f + β(r_m - r_f).
MM Proposition 1 — key point?
Firm value unaffected by capital structure in perfect markets.
Tax shield — benefit?
Reduces taxable income, increasing firm value.
Trade-off theory — balance?
Tax benefits vs bankruptcy costs.
Test your knowledge with 10 questions on Mastering Capital Structure and Modigliani-Miller Theory.
1. What is the primary focus of the chapter on capital structure and the Modigliani-Miller theorem?
2. According to the Modigliani-Miller Proposition 1 in a no-tax environment, how does capital structure affect a firm's value?
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