Corporate Finance Case Summary

A. Topic: Capital Structure / Dividends and Share Repurchase (Basics) Introduction Capital structure refers to the combination of debt and equity a company uses to fund and finance its operations. A mix of a company's long-term debt, specific short-term debt, common equity and preferred equity. For example, a firm that sells $20 billion in equity and $80 billion in debt is said to be 20% equity-financed and 80% debt-financed. The goal of a company’s capital structure decision is to determine the capital structure that to maximize the value of the company by minimize the cost of capital. The capital structure theory helps us understand the factors most important in the relationship between capital structure and the value of the company. Capital Structure Decision The capital structure decision is the relationship between the capital structure and the value of the firm. In traditional corporate finance, the objective in decision making is to maximize the value of the firm. Cost of capital refers to the opportunity cost of making a specific investment and it represents the overall cost of financing to the firm. The cost of capital is normally the relevant discount rate to use in analysing an investment. Many companies use a combination of debt and equity to finance their businesses, and for such companies, their overall cost of capital is derived from a weighted average cost of capital (WACC). WACC weights the cost of equity and the cost of debt by the percentage of each used in a firm’s capital structure. WACC should be based on market rates and valuation, not on book values of debt or equity. (WACC) is the marginal cost of raising additional capital and is affected by the costs of capital. In summary, the cost of capital is the cost of each component weighted by its relative market value. WACC weights the cost of equity and the cost of debt by the percentage of each used in a firm’s capital structure. WACC should be based on market rates and valuation, not on book...