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Introduction to Finance: Markets, Investments, and Financial Management, Fourteenth Edition by Edgar A. Norton, Ronald W. Melicher

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Chapter 18. Capital Structure and the Cost of Capital

Chapter Learning Objectives:

AFTER STUDYING THIS CHAPTER, YOU SHOULD BE ABLE TO:

  • Explain how capital structure affects a firm's capital budgeting discount rate.

  • Explain how a firm can determine its cost of debt financing and cost of equity financing.

  • Explain how a firm can estimate its cost of capital.

  • Explain how a firm's growth potential, dividend policy, and capital structure are related.

  • Explain how EBIT/eps analysis can assist management in choosing a capital structure. Describe how a firm's business risk and operating leverage may affect its capital structure.

  • Describe how a firm's degree of financial leverage and degree of combined leverage can be computed and explain how to interpret their values.

  • Describe the factors that affect a firm's capital structure.

Where We Have Been...

We have seen how a firm can choose a short-term or long-term financing strategy (Chapter 16) and familiarize itself with the workings of the financial markets, security pricing, and IPOs (Chapters 10 and 11). Part of the financing decision depends on the firm's asset needs. New asset purchases, restructurings, or corporate strategies may lead to the need for new financing or a new financing strategy for the firm. Likewise, changes in financial market conditions (due to fluctuations in interest rates, stock price, or exchange rates) may make new financial strategies look appealing.

Where We Are Going...

We've gone full circle now. Part 1 of this text, "Institutions ...

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