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Capital Structure Decisions: Introduction Up to this point when we calculated a firm's weighted average cost of capital (WACC), we assumed that the firm had a specific target capital structure. However, target capital structures often change over time, these changes affect the risk and cost of each type of capital, and thus impact the firm's WACC. In addition, changes in a firm's WACC impact its capital budgeting decisions and its stock price. Many factors influence capital structure decisions and determining the firm's optimal capital structure is not an exact science. In fact, even firms in the same industry often have dramatically different capital structures. Capital refers to investor-supplied funds—debt, preferred stock, common stock, and retained earnings. A firm's capital structure is the mix of debt, preferred stock, and common equity used to finance the firm's assets. Capital structure theory suggests that some optimal capital structure exists that simultaneously a firm's stock price and its cost of capital. The optimal capital structure strikes a balance between risk and return. A firm's target capital structure is generally set equal to the estimated optimal capital structure. However, the target may change over time as conditions change, but at any given moment, a well-managed firm's management has a specific structure in mind; and financing decisions are made so as to be consistent with this target capital structure. Actual capital structures also change over time for two different reasons: as a result of deliberate actions or as a result of market actions. First, if a firm is not currently at its target, it may deliberately raise funds in a manner that moves the actual capital structure toward its target. Second, the firm could incur high profits or losses that lead to significant changes in book value equity as shown on the balance sheet and to a decline in its stock price. Similarly interest rate changes due to changes in the general level of rates and/or changes in the firm's default risk could cause significant changes in its debt's market value. Both of these changes could result in large changes in its measured capital structure. Give the correct response to the following question. Which of the following is/are not investor-supplied fund(s)?
The dollar cost of debt for Coval Consulting, a U.S. research firm, is 7.4%. What is Coval Consulting's after-tax cost of debt in yen?
Illustrate diversification by naming several individual stocks and/ or various types bonds,
A couple plans on refinancing their existing mortgage. They currently owe $150,000 (which represents 70% of the value of the house) with 15 years left on the loan and monthly payments of $1300. A new loan will be financed at the 15 year fixed rate 1...
You own some bonds issued by Another Failing Airline Inc. (AFA). What is the fair price of one AFA bond?
Mrs. QE has decided to contest a $28,650 tax deficiency. She understands that she can initiate the litigation in district court or the Tax Court. Identify any reasons why she might prefer one trial court over the other.
Do you believe that the firm’s social responsibilities conflict with the ultimate goal of shareholder’s wealth maximization?
Finding the Dividend. Gontier Corporation stock currently sells for $64.13 per share. The market requires an 11 percent return on the firm's stock. If the company maintains a constant 5.5 percent growth rate in dividends, what was the most recent div..
As a banker, you would make short-term loans if you expect interest rates to go down in the future.
Using the financial statements for Kohl's Corporation and J.C. Penney Corporation, respectively, you will calculate and compare the financial ratios
Pearson Brothers recently reported an EBITDA of $13.5 million and net income of $3.9 million. It had $2.0 million of interest expense, and its corporate tax rate was 35%. What was its charge for depreciation and amortization?
If the interest rate on the firm's borrowed funds is 4.5% p.a., by how much will the annual interest paid by the firm be reduced?
What will be the invoice price of this bond when the bond settles assuming the bond follows street convention
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