1. Ch.13: Leverage & Capital Structure
Only pages , 385-9
Capital Structure
Financial Leverage
Bankruptcy

2. Capital Structure ratio of debt to equity
without changing assets, the firm could
issue bonds and buy back some stock
issue stock and pay off some debt
optimal or target capital structure

3. Financial Leverage Extent to which firm relies on debt.
Example: ACE has $20,000 in assets (market and book value). Tax rate = 40%.
Unleveraged, ACE would have $20,000 in equity and 2,000 shares outstanding.
Leveraged, ACE would have $10,000 in debt (at 12%) and $10,000 in equity with 1,000 shares outstanding.
Compare ACE under two capital structures, “Unlev” & “Lev,” in Bad & Good Economy.

4. Financial Leverage Example

5. Break -Even EBIT Recommended Practice
EPS = (EBIT - interest)(1-t)/shares, t = tax rate
Set EPS for lev and unlev equal and solve for EBIT
Compare Figure 13.1 p. 371
Recommended Practice
Self-Test Problem 13.1, p. 390
Problems on pp : 1, 3 (answers are on p.549)

6. Bankruptcy
Business Failure: firm has terminated with loss to creditors and owners
Legal Bankruptcy: firm or creditors petition federal court, a legal proceeding for liquidation (Chapter 7 Bankruptcy) or reorganization (Chapter 11 Bankruptcy)
Technical Insolvency: firm is unable to meet its financial obligations
Accounting Insolvency: BV liabilities > BV assets