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Flashcards in 03 Financial Struckture Deck (27):

What kinds of Equity are there?

- Common stock
- Preferred stock


What kinds of Debt are there?

- Subordinated debt
- Ordinary debt
- Secured debt


What are the Mezzanine finances

- Preferred Stock
- Subordinated Debt


How is the MV Debt Ratio Calculated

V_D / (V_E + V_D)


Which factors explain 27% of variation in market leverage

- Industry median leverage
- Tangibility
- Firm Size
- Market-to-book assets ratio
- Expected inflation


What does the Modigliani Miller theorem state?

Capital structure is independent of firm value in perfect capital markets


What are the assumptions of perfect capital markets?

- No taxes
- No cost of bankruptcy
- Perfect information
- No transaction cost for issuing debt and equity
- Investment decision not affected by capital structure


What is the second proposition of Modigliani Miller theorem?

- Return on equity increases in proportion to leverage
- Risk increases too
=> Effect of increased ROEE and increased equity beta cancel


How can you take tax effects into account?

Tax shield

V_L = V_U + T*D


What other risk do high debts hold

financial distress


What are the costs of financial distress?

Direct Costs:
Layers, accountants, consultants, ...

Indirect Costs:
loss of business, additional working capital ...


What does the trade off theory state?

Optimal capital structure balances tax-shields against costs of financial distress


What are the advantages of the trade off theory?

- Predicts moderate leverage
- Explains industry differences in capital structure
- Corresponds to management behavior


What are the disadvantages of the trade off theory?

- Some successful companies have little debt
- Relation between tax-shield and value is not empirically evident
- Empirically, tax sensitivity of capital structure seems to be too low


For what is FFO/Debt an indicator?

The Ability to repay debt form operating activities


For what is Debt/EBITDA an indicator?

Leverage ratio


For what is EBITDA/Interest expense an indicator?

The ability to pay interest expense


For what is OCF/Debt an indicator?

Ability to repay debt form operating activities


For what is FOCF/Debt an indicator?

Ability to repay debt from operating activities


For what is DCF/Debt an indicator?

Ability to repay debt from operating activities after capex and dividend payments


With which two violations of the Modigliani Miller Theorem does the Pecking-order theory deal?

- Asymmetric Information
- Transaction costs


What does the lemon market theorem state

For types of available goods:
good, bad, new and old
Only owner knows true value
Good products will not be traded (only lemons)


What does the pecking-order theory state

- Positive NPV projects are carried out if financed by retained earnings
- Positive NPV project will be carried out if financed by debt

Preference in financing sources
1. Retained earnings
2. Debit financing
3. External equity financing


With wich violation of the Modigliani Miller Theorem does the Free Cash-Flow Theory deal?

Investment decision depends on the capital structure


Why does excess cash lead to inefficiencies?

- Overinvestment (below cost of capital) -> empire building
-> Debt reduces cash and its financial obligation pressures managers


What is the Agency problem

Managers can maximize their wealth at expense of shareholders


What does the Free Cash Flow Theory State?

Optimal capital structure minimizes total agency costs

- Agency costs resulting from monitoring to prevent bondholder expropriation

- Agency costs of external equity resulting from monitoring managerial slack