Capital Structure and Tax Shields" Go to Yahoo! Finance’s Website, located at http://fin
Capital Structure and Tax Shields"
- Go to Yahoo! Finance’s Website, located at http://finance.yahoo.com/, and select a publicly traded company which interests you. Determine the company’s symbol (i.e., Apple = APPL) and navigate to the “SEC Filings” link on the left-hand side of the page under “COMPANY”. Review the debt structure of the company you have chosen by reading the company’s latest quarterly report and determining whether it has any convertible bonds or long-term debt. Recommend two actions that the selected company can take in order to optimize its capital structure. Provide a rationale for your recommendation.
Discussion Topic 2:
Please put the following paragraph in your own words.
The purpose of optimizing capital structure is to select that proportion of various forms of debts and equities that maximizes the firm’s value while minimizing the average cost of capital.
The Net Income to an optimal capital structure states that the total value of the firm changes with a change in the financial leverage. The NI approach holds true under certain assumptions. The NI approach assumes that the cost of debt is lower than the cost of equity. Therefore, an increase in the proportion of debt in the capital structure would result in a decrease in the firm’s average cost of capital. A lower cost of capital would result in an increase in the value of the firm.
The NI approach can be used to determine a firm’s optimum capital structure where the value of the firm is highest and the cost of the capital is lowest.
The Modigliani and Miller theorem is perhaps the most widely accepted capital structure theory. The first proposition, also referred to as the debt irrelevance theorem, states that the value of a firm is unaffected by its capital structure. The second proposition states that the required rate of return on equity increases as the firm’s debt equity ratio increases. This exactly offsets the less expensive funds represented by debt.