Financing and Capital Structure

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PART 1

  • Ross, S. A., Westerfield, R. W., Jaffe, J. F., & Jordan, B. D. (2018). Corporate finance: Core principles and applications (5th ed.). New York, NY: McGraw-Hill.
    • The following two chapters deal with the capital structure of a firm, that is, how a firm will finance itself, via debt or equity. These chapters examine the features, benefits, and negatives of financing through both financing types.
      • Chapter 14, “Capital Structure: Basic Concepts,” pages 423–450.
      • Chapter 15, “Capital Structure: Limits to the Use of Debt,” pages 451–479.

Among the two primary financing types of debt and equity, debt has features that are attractive to corporations. Since bonds are safer to investors than stock, the required rate of return to investors is lower on bonds or debt; hence, the cost to the issuing corporation is lower. Additionally, debt interest is tax deductible to the corporation, while stock dividends are not—this makes the cost of debt even cheaper than stock. However, there are risks to the issuing corporation associated with bonds, which are not present with stock financing. These include risks of financial distress, which could lead to bankruptcy.

By learning from companies that have experienced financing mistakes, you can assess the risks and benefits of each type of financing. Prepare a post that addresses the following:

  • Explain why debt financing is the cheapest form of financing but also the most dangerous form of financing.
  • Research a company that went bankrupt because of this and explain how and why as it is related to financing.

 

PART 2

  • Pysh, P. (2012). What is financial risk [Video] | Transcript. Retrieved from https://www.youtube.com/watch?v=-4mXnFK0ecM
  • Ross, S. A., Westerfield, R. W., Jaffe, J. F., & Jordan, B. D. (2018). Corporate finance: Core principles and applications (5th ed.). New York, NY: McGraw-Hill.
    • The following two chapters deal with the capital structure of a firm, that is, how a firm will finance itself, via debt or equity. These chapters examine the features, benefits, and negatives of financing through both financing types.
    • View the first 15 minutes of the video.

This week you completed an interactive exercise on computing WACC. In doing so, you saw the fluctuation of WACC by employing varying amounts of debt and equity financing components.

It is important for you to understand the cost of capital and what factors impact the level of costs because firms that can lower costs of capital typically have a better array of investing options and with that more opportunities to increase company value. As a result, all firms should strive to combine their financing mix to the point where the overall WACC is at its lowest point. This way, the lowest cost of financing will allow for a greater variety of investment projects to invest in.

For this discussion, make sure you have completed the Calculating WACC interactive exercise in this unit’s study. Based on your experience with the exercise and the materials for this week, indicate why companies have their own individualized capital structure and resulting WACC. How does WACC and capital structure affect the attractiveness of the firms to investors?

 

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