Mastering Capital Structure and Modigliani-Miller Theory

Estratto della scheda di revisione

Capital Structure & Modigliani-Miller Theorem Revision Sheet

1. 📌 Essentials

  • Capital structure is the ratio of debt and equity financing used by a firm.
  • WACC is the minimum return required, combining costs of debt and equity.
  • Cost of debt = risk-free rate + credit spread, adjusted for taxes.
  • Cost of equity is calculated via CAPM: re=rf+β(rm−rf)r_e = r_f + \beta (r_m - r_f).
  • Modigliani-Miller (MM) Proposition 1 states in perfect markets, capital structure is irrelevant to firm value.
  • Tax advantages of debt create a tax shield, increasing firm value (with taxes).
  • Trade-off theory balances tax benefits against bankruptcy and distress costs.
  • Pecking order theory favors internal funds, then debt, then equity.
  • Agency costs stem from conflicts between managers, shareholders, and debt-holders affecting capital decisions.
  • Market timing theory suggests firms issue equity when markets are overvalued and debt when interest rates are low.

2. 🧩 Key Structures & Components

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Anteprima del quiz

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?

3. According to the core concepts, what does the Weighted Average Cost of Capital (WACC) represent?

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Anteprima delle flashcard

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.

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