510 CHAPTER 13 Capital Structure Decisions
g .With the above points in mind, now consider the optimal capital structure for PizzaPalace.
(1) For each capital structure under consideration, calculate the levered beta, the cost of
equity, and the WACC.
(2) Now calculate the corporate value, the value of the debt that will be issued, and the re-
sulting market value of equity.
(3) Calculate the resulting price per share, the number of shares repurchased, and the re-
maining shares.
h .Considering only the capital structures under analysis, what is PizzaPalace’s optimal capital
structure?
i .What other factors should managers consider when setting the target capital structure?
Selected Additional References and Cases
For an article on signaling, see
Baskin, Jonathon, “An Empirical Investigation of the Peck-
ing Order Hypothesis,” Financial Management,Spring
1989, 26–35.
For an academic discussion of the issues, see
Caks, John, “Corporate Debt Decisions: A New Analytical
Framework,” Journal of Finance,December 1978, 1297–
1315.
Masulis, Ronald W., “The Impact of Capital Structure
Change on Firm Value: Some Estimates,” Journal of
Finance,March 1983, 107–126.
Piper, Thomas R., and Wolf A. Weinhold, “How Much
Debt Is Right for Your Company?” Harvard Business
Review,July–August 1982, 106–114.
Shalit, Sol S., “On the Mathematics of Financial Leverage,”
Financial Management,Spring 1975, 57–66.
For some insights into how practicing financial managers view the
capital structure decision, see
Kamath, Ravindra R., “Long-Term Financing Decisions:
Views and Practices of Financial Managers of NYSE
Firms,” Financial Review,May 1997, 331–356.
Norton, Edgar, “Factors Affecting Capital Structure Deci-
sions,” Financial Review,August 1991, 431– 446.
Pinegar, J. Michael, and Lisa Wilbricht, “What Managers
Think of Capital Structure Theory: A Survey,” Financial
Management,Winter 1989, 82–91.
Scott, David F., and Dana J. Johnson, “Financing Policies
and Practices in Large Corporations,” Financial Manage-
ment,Summer 1982, 51–59.
To learn more about the link between market risk and operating
and financial leverage, see
Callahan, Carolyn M., and Rosanne M. Mohr, “The Deter-
minants of Systematic Risk: A Synthesis,” The Financial
Review,May 1989, 157–181.
Gahlon, James M., and James A. Gentry, “On the Relation-
ship between Systematic Risk and the Degrees of Oper-
ating and Financial Leverage,” Financial Management,
Summer 1982, 15–23.
Prezas, Alexandros P., “Effects of Debt on the Degrees of
Operating and Financial Leverage,” Financial Manage-
ment,Summer 1987, 39– 44.
Here are some additional articles that relate to this chapter:
Easterwood, John C., and Palani-Rajan Kadapakkam, “The
Role of Private and Public Debt in Corporate Capital
Structures,”Financial Management,Autumn 1991, 49–57.
Garvey, Gerald T., “Leveraging the Underinvestment Prob-
lem: How High Debt and Management Shareholdings
Solve the Agency Costs of Free Cash Flow,” Journal of
Financial Research,Summer 1992, 149–166.
Harris, Milton, and Artur Raviv, “Capital Structure and the
Informational Role of Debt,” Journal of Finance,June
1990, 321–349.
Israel, Ronen, “Capital Structure and the Market for Corpo-
rate Control: The Defensive Role of Debt Financing,”
Journal of Finance,September 1991, 1391–1409.
See the following two articles for additional insights into the rela-
tionship between industry characteristics and financial leverage:
Bowen, Robert M., Lane A. Daley, and Charles C. Huber,
Jr., “Evidence on the Existence and Determinants of
Inter-Industry Differences in Leverage,” Financial Man-
agement,Winter 1982, 10–20.
Long, Michael, and Ileen Malitz, “The Investment-Financ-
ing Nexus: Some Empirical Evidence,” Midland Corporate
Finance Journal,Fall 1985, 53–59.
For a discussion of the international implications of capital struc-
ture, see
Rutterford, Janette, “An International Perspective on the
Capital Structure Puzzle,” Midland Corporate Finance
Journal,Fall 1985, 60–72.
TheCases in Financial Management series contains many of
the concept we present in Chapter 13.
Case 9, “Home Security Systems, Inc.,” Case 10, “Kleen
Kar, Inc.,” Case 10A, “Mountain Springs, Inc.,” and Case
10B, “Greta Cosmetics, Inc.,” which present a situation
similar to the Strasburg example in the text.
506 Capital Structure Decisions
