Finished my revision for CFP topics 3, 4 & 5 this weekend; Hoping to start on topic 6 tonight & finish it off tomorrow morning. The three topics dealt with debt policy & whether capital structure matters for an organization. Ultimately there is no one optimal capital structure & there are several factors which may influence a company's choice of structure- the main factors being the potential tax-shield generated by debt & the costs of potential financial distress. The costs of financial distress will be higher for a firm with less material assets--- eg. growth companies whose profits are mainly based on knowledge & human capital structure (Google is one such company)--- as non-physical assets cannot be liquidated to raise extra funds.
However when it comes to raising new money in general a firm will stick to a hierarchy of: internal funds, then debt & finally new equity. This is because a manager who knows their shares are under-priced on the market will be reluctant to sell more while a manager who realizes their shares are over-priced on the market will be happy to issue more. Shareholders realise this & for this reason the share price will drop when managers try to issue new shares. Therefore a pessimistic, yet intelligent manager still wouldn't issue extra shares. (This doesn't apply in all cases- when the issue of equity is clearly necessary the stock price is unlikely to experience an abnormal fall)
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