Fundamentals of Corporate Finance

14

Capital Structure Policy

Learning Objectives

Describe the two Modigliani and Miller propositions, the key assumptions underlying them, and their relevance to capital structure decisions. Use Proposition 2 to calculate the return on equity.

Discuss the benefits and costs of using debt financing and calculate the value of the income tax benefit associated with debt.

Describe the trade-off and pecking order theories of capital structure choice and explain what the empirical evidence tells us about these theories.

Discuss some of the practical considerations that managers are concerned with when they choose a firm's capital structure.

At the end of 2012 the average firm in the U.S. computer industry had debt obligations that represented less than 10 percent of the market value of its total capital. Some of the best-known computer industry firms, such as Apple, CISCO, Dell, Google, Intel, Microsoft, Oracle, and Qualcomm, actually had more cash than debt. In other words, these companies ...