Capital Structure Theory
This concept describes the reduction in taxable income for a company that occurs by claiming allowable deductions such as interest on debt
Tax Shield
This model is used to calculate the cost of equity by adding a risk premium (Beta times Market Risk Premium) to the risk-free rate.
CAPM
This type of leverage measures the sensitivity of a company’s EBIT to changes in its sales volume.
Operating Leverage
This term describes the reduction in the ownership percentage and Earnings Per Share of existing stockholders when new shares are issued.
Dilution
This is the risk that remains even after a portfolio is fully diversified.
Systematic Risk
This phenomenon occurs when a firm uses fixed-cost financing to increase the Return on Equity (ROE), a benefit realized only when the return on assets exceeds the interest cost of the debt.
Financial Leverage
When a company like Marriott or Pioneer operates in different industries, it should use these instead of a single corporate WACC to evaluate projects.
Divisional Hurdle Rates
This ratio measures the sensitivity of a company’s Earnings Per Share (EPS) to changes in its Operating Income (EBIT).
Degree of Financial Leverage (DFL)
Carrefour’s strategy of maintaining low prices and low margins while focusing on high inventory turnover is known as this type of retailing.
Discount Retailing
In the electricity sector case, this is the primary reason why a company must earn a return at least equal to its cost of capital
Value Creation (or Avoiding Value Destruction)
When choosing between these two financing methods, a firm must weigh the risk of ownership dilution and loss of control against the risk of committing to fixed legal obligations.
Common Stocks and Bonds
This adjustment must be made to a "comparable" company's Beta to remove the effects of its specific financial leverage before applying it to another firm.
Unlevering the Beta
This is the point on an EBIT-EPS chart where two different financing plans yield the exact same Earnings Per Share.
Indifference Point
This financial state occurs when a firm (like Massey-Ferguson) is unable to meet its debt obligations, often leading to restructuring or bankruptcy.
Insolvency
This is the specific risk of a project that can be eliminated through diversification
Unsystematic Risk
It is the specific risk associated with a firm’s operations, independent of its financial structure, often measured by the "Unlevered Beta."
Business Risk / Operating Risk
This is the spread between the return on the S&P 500 composite and the return on a risk-free investment (like Treasury Bills).
Market Risk Premium?
This phenomenon occurs when a high proportion of fixed costs causes a small change in sales to result in a large percentage change in EBIT
Operating Leverage Effect
This strategy, used by Marriott, involves selling off hotel assets while retaining long-term management contracts to improve return on equity.
Asset-Light Strategy
A measure of how much a stock’s returns move with the overall market; a value of 1.0 means it moves exactly with the market
Beta
This is the cost incurred when a firm’s debt level is so high that it faces the possibility of default, including legal fees and loss of customers or suppliers.
Financial Distress Costs
This approach prevents a company from over-investing in high-risk sectors by assigning unique hurdle rates to business units based on their specific economic risks.
Divisional cost of capital
If a firm's Operating Leverage is 1.5 and its Financial Leverage is 2.0, this is the resulting Total Leverage.
3.0
This is the maximum amount of debt a company can realistically support without significantly increasing the probability of financial distress.
Debt Capacity
This is the term for the risk that a firm might not be able to "roll over" or renew its debt when it matures.
Refinancing Risk