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.
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.
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.
Capital structure — definition?
Ratio of debt and equity financing.
WACC — role?
Minimum required return considering capital mix.
Cost of debt — formula?
Risk-free rate + credit spread, Tax-adjusted.
Cost of equity — calculation?
CAPM: r_f + β(r_m - r_f).
MM Proposition 1 — key point?
Firm value unaffected by capital structure in perfect markets.
Tax shield — benefit?
Reduces taxable income, increasing firm value.
Trade-off theory — balance?
Tax benefits vs bankruptcy costs.
Answer 10 questions on Mastering Capital Structure and Modigliani-Miller Theory.
1. What is the primary focus of the chapter on capital structure and the Modigliani-Miller theorem?
2. According to the core concepts, what does the Weighted Average Cost of Capital (WACC) represent?
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