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Corporate Finance and MM Approach: Doc

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Added on  2020-05-08

Corporate Finance and MM Approach: Doc

   Added on 2020-05-08

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Running head: CORPORATE FINANCECorporate FinanceName of the Student:Name of the University:Author’s Note:Course ID:
Corporate Finance and MM Approach: Doc_1
1CORPORATE FINANCETable of ContentsQuestion 1: Financial leverage and theories of capital structure...............................................21.1 Two advantages of debt over equity funding:..................................................................21.2 Impact of financial leverage on shareholder returns:.......................................................21.3 Jensen’s free cash flow theory to depict the relationship of limited opportunity firms tohave high or low debt levels and role of debt in curbing such behaviour:.............................2Question 2: Modigliani-Miller (MM) capital structure irrelevance propositions......................32.1 Three assumptions in MM approach:...............................................................................32.2 Reasons that such assumptions do not hold in practice:..................................................32.3 Impact of the reconciliation of these assumptions on investors and/or firm preferencefor or against debt in capital structure:...................................................................................4References:.................................................................................................................................5
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2CORPORATE FINANCEQuestion 1: Financial leverage and theories of capital structure1.1 Two advantages of debt over equity funding:An organisation that raises funds through debt instead of equity primarily has thefollowing two advantages:The lender does not have any control over the business. Once the loan is repaid, thereis no relationship with the financier.Secondly, the interest paid on the part of the organisation is tax deductible. 1.2 Impact of financial leverage on shareholder returns:The financial leverage is utilised in magnifying the earnings of the shareholders. It isreliant on the assumption that the fixed cost funds could be accumulated at a price lowercompared to the organisation’s rate of return on its assets (Ehrhardt & Brigham, 2016).At thetime the variation between the earnings funded by fixed asset funds and the prices of suchfunds are distributed to the equity shareholders, they would receive additional earningswithout enhancement of their investments.As a result, return on equity and earnings per share of the organisation increase.Conversely, if the organisation obtains fixed cost funds at a greater cost compared to earningsfrom such assets, there would be a fall in earnings per share and return on equity. Thus, thesetwo measures help in measuring the impact of financial leverage on shareholder returns. 1.3 Jensen’s free cash flow theory to depict the relationship of limited opportunity firmsto have high or low debt levels and role of debt in curbing such behaviour:According to Jensen’s free cash flow theory, it is a method of looking at the cash flowof an organisation to determine the amount available for distribution among the stock holdersof the organisation. In addition, Jensen posited that the organisations generating cash in
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