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Flashcards in 03 Lecture Deck (11):
1

What are the Mezzanine financing instruments

Between Equity and Debt

- Convertible Bonds
- Preferred Stocks
- Subordinated debt

2

What is the most important mechanism between equity and debt

risk and return

others are (Control rights, Priority of being served)

3

How are equity holders are called

Residual Claimholders

4

What explains the 27% variation in leverage

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

5

What are the assumptions of the Modigliani-Miller Theory and what does it state?

1. No Taxes
2. No cost of bankruptcy
3. Perfect information
4. No transaction costs for issuing debt and equity
5. Investment decisions not affected by capital structure

=> Firm value is independent of its capital structure

6

What does the trade-off theory state?

Optimal capital structure balances tax-shield against cost of financial distress

7

What effects does the announcement of an equity increase have?

- Reduces the share price
- Increases the cost of equity

8

What does the pecking order theory state?

Pecking order theory suggests preference in financing sources
1. Retained earnings
2. Debt financing
3. External equity financing

9

What are the main assumptions of the free cash flow theory

- Separation of ownership and control
- Asymmetry information between management and investors?

10

What is the main result of the free cash flow theory?

Managers can maximize their wealth at expense of shareholders

11

What are problems of too much debt according to the free cash flow theory?

- Assets Substitution:
Incentive to increase the riskiness of your company

- Debt Overhang
Equityholders will not give money for projects