The Optimal Capital Structure Debt
The optimal capital structure Is there such a thing?
Is there an Optimal Capital
Structure?
• Miller and Modigliani:
• 1. You cannot derive value from financing strategies. If you finance with debt in a world with taxes, then you might add value from interest payments tax shields
• Question:
• If this is true for everyone, then why do not find more debt financing in more companies, i.e you find little debt in technological companies
Myers and the Pecking Order
• Prof. Myers found the following preferences among US and
World companies for financing growth:
1. Retained Earnings
2. Debt
3. Stock issues
Questions:
Are retained earnings cost free? What is the cost of capital of retained earnings? Why are they preferred?
Financing Decision Subject to Asset
Type
• Myers research also showed some interesting correlations:
1. Firms with high value invested in fixed assets tend to have more debt
2. Firms with large values attached to intangible assets preferred retained earnings (especially if expectations of growth were high)
3. Cash cows with high profits who could benefit from tax deductions not always had debt level consistent with this value (maybe because they got large tax deductions from depreciation without the financial risk)
Capital Structure and the Trade Off for Stakeholders
Is there a trade off between the objective of maximizing shareholder value and the objective of achieving an optimal capital structure?
Let’s examine the possible effects of debt:
1. From a purely operative point of view, the firms earning stream is not affected by interest payments if we use either after tax Ebit or we adjust net profits properly
Impacts of Leverage on
Stakeholders
1. From a purely operative point of view, the firms earning stream is not affected by interest payments if we use either after tax EBIT or we adjust net profits properly 2. As the firm adds more debt, interest payments raise and bondholders (creditors) receive a larger part of the revenues while
Is there an Optimal Capital
Structure?
• Miller and Modigliani:
• 1. You cannot derive value from financing strategies. If you finance with debt in a world with taxes, then you might add value from interest payments tax shields
• Question:
• If this is true for everyone, then why do not find more debt financing in more companies, i.e you find little debt in technological companies
Myers and the Pecking Order
• Prof. Myers found the following preferences among US and
World companies for financing growth:
1. Retained Earnings
2. Debt
3. Stock issues
Questions:
Are retained earnings cost free? What is the cost of capital of retained earnings? Why are they preferred?
Financing Decision Subject to Asset
Type
• Myers research also showed some interesting correlations:
1. Firms with high value invested in fixed assets tend to have more debt
2. Firms with large values attached to intangible assets preferred retained earnings (especially if expectations of growth were high)
3. Cash cows with high profits who could benefit from tax deductions not always had debt level consistent with this value (maybe because they got large tax deductions from depreciation without the financial risk)
Capital Structure and the Trade Off for Stakeholders
Is there a trade off between the objective of maximizing shareholder value and the objective of achieving an optimal capital structure?
Let’s examine the possible effects of debt:
1. From a purely operative point of view, the firms earning stream is not affected by interest payments if we use either after tax Ebit or we adjust net profits properly
Impacts of Leverage on
Stakeholders
1. From a purely operative point of view, the firms earning stream is not affected by interest payments if we use either after tax EBIT or we adjust net profits properly 2. As the firm adds more debt, interest payments raise and bondholders (creditors) receive a larger part of the revenues while