Capital Structure Overview Of The Financing Decision

In the last few chapters, we have examined the investment principle, and argued that projects that earn a return greater than the minimum acceptable hurdle rate are good projects. In coming up with the cost of capital, which we defined to be the minimum acceptable hurdle rate, however, we used the existing mix of debt and equity used by the firm.

In this chapter, we examine the choices that a firm has in terms of both debt and equity and how these choices change over a firm's life cycle. In particular, we look at how the choices change as a firm goes from being a small, private business to a large publicly traded corporation. We then evaluate the basic tradeoff between using debt and equity by weighing the benefits of borrowing against its costs. We close the chapter by examining when the costs of borrowing exactly offset its benefits, i.e, debt becomes irrelevant, and the implications for corporate finance.

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