Capital Structure and Firm Value
15 Pages Posted: 12 Jun 2009
This note explores the interaction between the use of debt and firm value and provides a brief perspective on the use of debt. It also introduces the notions of financial and operating leverage. In addition, it covers the impact of the use of debt in the presence of no taxes, corporate taxes only, and both personal and corporate taxes.
CAPITAL STRUCTURE AND FIRM VALUE
The 1980s were the decade of debt. Numerous articles and commentators have discussed the growing use of debt by American nonfinancial corporations. These companies nearly doubled their debt from 1982 through 1988. Deals such as the $ 11 billion purchase of Kraft by Phillip Morris and the leveraged buyout of RJR Nabisco for $ 17.6 billion, which involved huge amounts of borrowing, focused attention on the issue of debt. As corporate debt became an important issue, we saw the following kinds of headlines:
“Has the Debt Binge Gone too Far?” Fortune, April 25, 1988;
“Learning to Live with Leverage, New Risks, New Rewards--and
Bigger Failures?” Business Week, November 7, 1988.
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Keywords: capital structure, financial policy, leverage, liability management, tax issues, valuation
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