Capital Structure Flashcards
What is the “Cost of Capital”?
- The cost of financing for a company;
- The rate of return that suppliers of capital require as compensation for their contribution of capital.
What is the “Cost of Debt”?
The required return on debt financing for a company.
What is the “Cost of Equity”?
The required rate of return by equity investors to compensate for both the time value of money and the risk.
What is the “Weighted-Average Cost of Capital” or WACC ?
A weighted average of the after-tax required rates of return on a company’s equity, debt, preferred stock, and other long-term financing sources.
What is a “Capital Structure”?
- The mix of debt and equity that a company uses to finance its business.
- The company’s specific mix of long-term financing.
What is a “Capital-Intensive” business?
Companies or business activities that are characterized by:
- Low Fixed-Asset Turnover
- High Percentage of CAPEX to Sales
- High Net-Working-Capital to Sales Ratio
What is a “Capital-Light” Business?
Also known as an asset light business.
Characterized by:
- High fixed-asset turnover ratio.
- Low percentage of CAPEX to sales.
- Low net-working-capital to sales.
What is “Convertible Debt”?
A debt instrument that gives the holder the right to exchange the instrument for a specified number of common shares in the issuing company.
What is “Operating Leverage”?
The sensitivity of a firm’s operating profit to a change in revenues, which is determined by the composition of fixed and variable operating costs.
What is a “Debt-Tax Shield”?
The tax benefit from interest paid on debt being tax deductible from income, equal to the marginal tax rate multiplied by the value of the debt.
What is the “Static trade-off theory of capital structure” ?
A theory pertaining to a company’s optimal capital structure. The optimal level of debt is found at the point where additional debt would cause the cost of financial distress by a greater benefit than the incremental benefit of the tax shield.
What is the “optimal capital structure” ?
The capital structure at which the value of the company is optimized.
What is a “Target Capital Structure” ?
Management’s desired proportions of debt and equity financing, usually stated on a book value basis or indirectly using a leverage metric, such as net debt to EBITDA or credit rating.
What is “Asymmetric Information”?
Also known as information asymmetry. It’s the differential of information between corporate insiders and outsiders regarding a company’s performance and prospects.
What is “Pecking Order Theory” ?
The theory that managers consider how their actions might be interpreted by outsiders and thereby order their preferences for various forms of various corporate financing. Forms of financing that are the least visible to outsiders (e.g., internally-generated funds) are preferable to managers, and those that are most visible (e.g., equity issuance) is least preferable.
