Sub: Finance Topic: Capital Structure
Effect of leverage on creditors and share holders.
ClassOf1 provides expert guidance to College, Graduate, and High school students on homework and assignment problems in
Math, Sciences, Finance, Marketing, Statistics, Economics, Engineering, and many other subjects.
In finance, as in accounting, the two sides of the balance sheet must be equal. In the previous
problem, we valued the asset side of the balance sheet. To value the other side, we must value
the debt and the equity, and then add them together.
0% Debt/ 25% 50%
100% Debt/75% Debt/50%
Equity Equity Equity
Cash flow to creditors:
Interest 0 $125 $250
Pretax cost of debt 0.05 0.05 0.05
Value of debt:
(Interest/kd) - - -