Finance 2 Flashcards
(30 cards)
After tax payoff of buying shares before dividend
After tax payoff of buying shares after dividend issue
Net neutral probability for binomial
European Scholes formula
D1 and D2 for black scholes formula
What is unlevered cost of equity
Cost of equity when the business is only made up of debt
Cost of equity equation
Value of equity
Coupon bond price
What is the yield to maturity
Half of IRR of coupon bond where Investment is the current market price of the bond
What does the Trade-Off Theory explain regarding capital structure?
Firms balance tax benefits of debt against costs of financial distress. Optimal structure exists where marginal benefit equals marginal cost.
This theory emphasizes finding an ideal point where the advantages of debt (like tax shields) equal the disadvantages (like potential bankruptcy costs).
What is the central idea of the Pecking Order Theory?
Firms prefer internal financing, then debt, and equity as last resort due to asymmetric information. Explains why profitable firms use less debt.
This theory suggests that firms prioritize funding sources based on the cost of obtaining them and the information asymmetry between managers and investors.
How does the Agency Cost Theory describe the role of debt?
Debt can reduce agency costs of free cash flow by committing managers to payouts, but creates creditor-shareholder conflicts.
This theory highlights how debt may align the interests of managers and shareholders while also introducing potential conflicts with creditors.
What does the Market Timing Theory suggest about capital structure?
Firms issue equity when market valuations are high and repurchase when low, leading to time-varying capital structures.
This theory reflects the idea that firms take advantage of market conditions to optimize their capital structure over time.
What is the implication of the Signaling Theory in capital structure decisions?
Debt issuance signals confidence (as managers know true value), while equity may signal overvaluation.
This theory indicates that the type of financing chosen by a firm can convey information about its perceived value to the market.
List the main theories explaining capital structure decisions.
- Trade-Off Theory
- Pecking Order Theory
- Agency Cost Theory
- Market Timing Theory
- Signaling Theory
Each theory provides a different perspective on the factors that influence a firm’s choice between debt and equity financing.
Why may underpricing occur
Value of business based on unlevered value and debt
Value of business= unlevered value + (Amount of debt held*tax rate)
Value of business using earnings and debt
Tax dividend theory
Low marginal tax rates prefer high dividend and vice versa
Income dividend theory
High income prefer low dividend and vice versa
Catering theory
Dividend is based on investor demand
Takeover motives
Tax losses
Unused debt capacity
Tax inversion
Free cash flow theory
Reduce managerial entrenchment
Reduce stakeholder options and power( mostly targeting suppliers, customers and employees)
Innovation
Kill competition
