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1、Capital Structure: Theories and EmpiricsReferences:Brealey, Myers, and AllenChapter 17, and 18 Arnold: Chapter 21 Brealey, Myers, and Marcus: Chapter 131 Introduction2Concept checking Operating gearing The fixed/variable cost ratio High operating gearing: high fixed cost/low variable cost Car, steel
2、 manufacturing, utilities Financial gearing The proportion of debt in the capital structure Leverage: gearingIntroduction34Measuring firms financial gearing Capital gearing (1) Long-term debt/shareholders funds (D/E) L/T debt: amounts falling due after more than one year Share holders funds: the net
3、 asset Both figure taken from balance sheet Rationale Indicates firms ability to sell assets to repay debts Criticism Book value saleable value Have values between zero and infinity difficult to compare across firmsIntroduction5Measuring firms financial gearing Capital gearing (2) L/T debt/(L/T debt
4、 + Shareholders funds) D/(D+E) A fraction of all long-term capital 0%, 100% Capital gearing (3) All borrowing/(all borrowing + shareholders funds) Including short-term debt Commercial papers Over-draftIntroduction6Measuring firms financial gearing Capital gearing (4) LT/debt/Total market capitalisat
5、ion Market-value-based gearing measureCriticismValuation of firm assets is a notoriously difficult taskLiquidation value true value of the businesse.g. advertising, fashion design, dot-comHence biased measure of firms ability to repay debts Income gearing interest charges/EBIT Example, Arnold Exhibi
6、t 21.3 (omitted)Introduction7Given constant future cash flows, can managers increase shareholder value simply by altering debt/equity ratio? i.e. is there an optimal gearing levelIntroduction8Debt financing Cheaper and riskier 1. Interest payments are tax-deductible 2. Lower transaction costs 3. Len
7、ders require lower rate of return Less risky from lenderss point of view 1) Prior claims 2) Security often provided 3) Covenants imposedIntroduction9Traditional view Too little debt: forgone opportunities of cheap debt capital Too much debt: higher required rate of return reduces shareholder valueIn
8、troduction10Modigliani and Miller (1958) Gearing level is inconsequential to firm value Perfect knowledge Individuals can borrow and lend at the same rate as corporations Zero taxation Zero cost of financial distressModigliani and Miller (1963) with taxes, the best gearing level is as high as possib
9、leBut firms tend to avoid very high gearing levels, hence the capital structure puzzleIntroduction1112The Effect of Gearing with Zero Taxation and CertaintyPivot plc. needs 1 million. Required return on all-equity firm is 15%. The expected annual cash flow is a constant 150,000 in perpetuity. Three
10、different financing structure: Structure 1: All equity (1 m shares sold at 1 each) Structure 2: 50:50 (half million borrowed at 10% and half million shares sold at 1) Structure 3: 70:30 (700K borrowed at 10% and 300K shares sold at 1)13Structure 1Structure 2Structure 3Debt: Equity0:1,000,000500,000:
11、500,000700,000:300,000Annual CF150,000150,000150,000Interest payment (10%)050,00070,000Net income (equity)150,000100,00080,000Return to E (%)15%20%27%Effect of Gearing under Certainty: ROE increases proportionately with leverage ratio14Structure 1Structure 2Structure 3Debt: Equity0:1,000,000500,000:
12、500,000700,000:300,000Cost of D (%)10%10%10%Cost of E (%)15%20%27%WACC (%)15%15%15%Effect of Gearing under Certainty: The cost of capital is unaffected by leverage ratio15Structure 1Structure 2Structure 3Debt: Equity0:1,000,000500,000:500,000700,000:300,000Value of Equity1,000,000500,000300,000Value
13、 of debt0500,000700,000Value of firm1,000,0001,000,0001,000,000Effect of Gearing under Certainty: The value of firm is unaffected by leverage ratio16Effect of Gearing with UncertaintyEffect of Gearing with UncertaintyBusiness risk The variability of firmss operating income Measured by the dispersion
14、 of returns for the all-equity capital structure Caused purely by business-related factors e.g. Drop in demand for computer engineering after the millennium bug e.g. Volatile prices of steel More example?Financial risk The additional variability in returns to shareholders arising from the use of deb
15、t Higher the debt, higher the financial risk,17Financial risk: Increases with LRBusiness risk: Independent of LRRisk-free rate: Time value of moneyLevel of gearing (e.g. Debt/Equity)Required Return (%)18The Effect of Gearing with UncertaintyThe Effect of Gearing with UncertaintyTwo firms, U and L, w
16、ith the same operating gearing, business risk, and probability distribution of gross income (GI). They only differ with respect to their use of debt (capital structure).Firm UFirm L No debt10,000 12% 20,000 equity10,000 equity 0% tax rate0% tax rate19Firm U: UnleveragedFirm L: leveragedBadAvg.GoodBadAvg.GoodP
