Financial Leverage and Capital Structure Policy

Flashcards covering key terms and concepts from Financial Leverage and Capital Structure Policy.

Financial Leverage

The extent to which a firm relies on debt in its capital structure.

Capital Structure

The mix of debt and equity used by a firm to finance its operations.

Weighted Average Cost of Capital (WACC)

The firm's overall cost of capital, calculated as a weighted average of the costs of its various sources of capital.

Modigliani & Miller Propositions

Theorems stating that under certain conditions, a firm's capital structure does not affect its overall value.

Pecking Order Theory

A theory suggesting that firms prefer to use internal financing first, followed by debt, and issuing equity as a last resort.

Break-even EBIT

The level of Earnings Before Interest and Taxes at which a firm's earnings per share remain unchanged after the introduction of debt.

Bankruptcy Costs

Direct and indirect costs associated with a firm's bankruptcy process.

Direct Bankruptcy Costs

Costs directly associated with bankruptcy, such as legal and administrative expenses.

Indirect Bankruptcy Costs

Costs incurred by a firm to avoid bankruptcy, which can include operational disruptions and loss of valuable employees.

Interest Tax Shield

The tax savings realized by a firm due to the tax deductibility of interest payments on debt.

Marketed Claims

Claims that can be bought and sold in the market, such as those of stockholders and bondholders.

Non-marketed Claims

Claims that cannot be freely traded in markets, such as those of governments and potential litigants.

Static Theory of Capital Structure

A theory suggesting that a firm should borrow to the point where the marginal benefit of the tax shield equals the marginal cost of financial distress.

Absolute Priority Rule (APR)

A legal principle that establishes the order of claims on a company's assets during liquidation.

Reorganization

Restructuring of a failing firm with the intention of continuing its operations.

Liquidation

Termination of the firm and selling of its assets to pay off creditors.