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Chapter 15 Capital Structure Policy Agenda   Learning Objectives Principles Used in This Chapter 1.A Glance at Capital Structure Choices in Practice 2.Capital Structure Theory 3.Why Do Capital Structures Differ Across Industries? 4.Making Financing Decisions Learning Objectives 1. 2. 3. Describe a firm’s capital structure. Explain why firms have different capital structures and how capital structure influences a firm’s weighted average g g cost of capital. Use the basic tools of financial analysis to analyze a firm’s financing decision. 1 Principles Used in This Chapter  Principle 2: There is a Risk-Return Tradeoff. ◦ Managers are often tempted to take on more debt as it can increase the rate of return earned on the stockholders’ investment in the firm. ◦ Ho e e this higher return comes with a cost. However, highe et n ith cost  The higher use of debt financing makes the firm’s stock riskier, which increases the required rate of return on stock.  In addition, it increases the default risk of the firm. Principles Used in This Chapter  Principle 3: Cash Flows Are the Source of Value. ◦ Capital structure choice impacts the cash flows and thus affects the value of the firm. 15.1 A Glance at Capital Structure Choices in Practice 2 A Glance at Capital Structure Choices in Practice  The primary objective of capital structure management is to maximize the value of the shareholders’ equity. The resulting financing mix that maximizes shareholder value is called the optimal capital structure.  Defining the Firm’s Capital Structure  A firm’s capital structure consists of owner’s equity and its interest bearing debt, including short-term bank loans. The combination of firm’s capital structure plus the firm’s non-interest bearing liabilities such as accounts payable is called the firm’s financial structure.

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