Introduction to Corporate Finance

what companies do

CAPITAL STRUCTURE

13-1 What is financial leverage and what are its effects?

13-2 The Modigliani and Miller propositions

13-3 The M&M capital structure model with taxes

13-4 The trade-off model of capital structure

13-5 The pecking-order theory

13-6 Do we have a winning model?

When companies decide how to finance their

activities and investments, they choose between

issuing shares (i.e. selling part of their value to

external parties) or borrowing. This equity–debt

choice is an important one in imperfect capital

markets – those in which there are costs of changing

capital structure, and where the markets are

imperfectly informed about companies’ plans; for

instance, the markets may hear about a company’s

plans, but may not believe they will be achieved and

so be hesitant about investing. If the external capital

markets are confident that a company’s plans are

achievable, capital in the form of equity or debt will

be provided, for a price. The extract below describes

a recent insight about the improving confidence of

capital markets in investing in Australian companies.

CHANGING CAPITAL STRUCTURES: CONFIDENCE IN CREDIT AVAILABILITY AT

FIVE-YEAR HIGH

Borrowers are once again attuned to

credit availability and banks are willing

to lend. Respondents’ awareness of and

confidence in local credit availability is

at its highest level [for many years]. This

is an important element for a healthy

transaction environment. [Over the past

year] less than half of respondents felt

credit availability was improving at the

local level. Now, banks are keen to do

business and this has shot up to 71%,

with only 6% of respondents who believe

it will decline. Anticipated global credit

availability is also at an all-time post-

GFC high, up to 64%. A massive 94% of

Australasian executives see local credit

availability as stable or improving; only 6%

expect a decline.

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