Chapter 13 leverage & capital structure

Learning Goals: Discuss leverage, capital structure, break-even analysis, the operating break-even point and the effects of changing costs on the break-even point..  Describe the bas

to accompany

Chapter 13

Leverage & Capital Structure

Learning Goals:

 Discuss leverage, capital structure, break-even

analysis, the operating break-even point and the

effects of changing costs on the break-even point.

 Understand the different types of leverage and the

relationships between them.

 Describe the basic types of capital, external

assessment of capital structure and capital structure theory.

 Explain the optimal capital structure using a graphic view of the firm’s cost of capital functions and a zero growth valuation model.

 Discuss the EBIT–EPS approach to capital structures.

 Review the return and risk of alternative capital

structures and their linkage to market value, and other important considerations related to capital structure.

 Results from the use of fixed cost assets or funds

to magnify returns to the firm’s owners.

 An increase in leverage generally results in an

increase in return and risk.

 A decrease in leverage will generally result in a

decrease in risk and return.

 Management has control over the risk introduced through the use of leverage within an company.

Types Of Leverage

 Three types:

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EBIT-EPS Approach To

Capital Structure

EPS over the expected range of EBIT

maximisation of shareholder wealth.

Comparing Alternative

Capital Structures

Page 590.

Comparing Alternative

Capital Structures

Choosing The Optimal

Capital Structure

 The wealth maximisation goal requires us to

consider both return and risk when making capital structure decisions.

 We must link market value with the return and risk associated with alternative capital structures There are two ways in which this can be achieved:

• Using CAPM

• Linking