LPC Notes Corporate Finance Revision Notes (Distinction level) 2023{211581}

Is there a clever way to finance firm that increase firm value? - -MM capital structure irrelevance theorem states that it is only the expected CFs and risk of the project that determine firm value - capital structure is irrelevant -MM Proposition I assumption - -Firm's CFs are unaffected by D-E choice -MM Proposition II states - -The expected return on equity is positively related to leverage because the risk to equity holders increases with leverage. When D/E-ratio increases, the expected return on equity increases (due to higher risk on equity in a company with debt). -What MM misses - -Takes CF as given, and misses how they are formed. D and E often matter because they often affect firm's investment strategies, and therefore also CFs. -Why differences in leverage across industries? - -1) Risk of CFs - if an industry has very volatile CF it may not be able to handle its debt, which affects the cost of debt. For example oil and gas industry. 2) Collateral - the amount of assets that have been put up to secure a loan matters for how much the firm are able to borrow. Example - Airline companies have a lot of collateral. -Benefits of Debt - -- Tax-shield - Impose effective internal control