{"id":503,"date":"2014-06-24T16:12:13","date_gmt":"2014-06-24T16:12:13","guid":{"rendered":"http:\/\/zh.aceessays.com\/tc\/?p=503"},"modified":"2015-01-18T20:41:05","modified_gmt":"2015-01-18T20:41:05","slug":"the-traditional-approach","status":"publish","type":"post","link":"https:\/\/www.aceessays.com\/tc\/the-traditional-approach\/","title":{"rendered":"The traditional approach"},"content":{"rendered":"<h3>The traditional approach<\/h3>\n<ul>\n<li>Ke increases as gearing increases due to rising financial risk and, later, bankruptcy risk.<\/li>\n<li>Kd rises at high levels of gearing due to bankruptcy risk.<\/li>\n<li>As company starts to replace expensive equity with cheaper debt, WACC falls.<\/li>\n<li>As gearing continues to increase, Ke and Kd increase, offsetting the benefit of cheap debt.<\/li>\n<\/ul>\n<h3>Net income approach<\/h3>\n<ul>\n<li>Capital markets are assumed to be perfect.<\/li>\n<li>No risk of bankruptcy so Kd curve is flat.<\/li>\n<li>Linear increase in Ke due to increasing financial risk.<\/li>\n<li>As company gears up and replaces equity with debt, benefit of cheaper debt is exactly balanced by the increasing cost of equity.<\/li>\n<\/ul>\n<ul>\n<li>No optimal capital structure is found.<\/li>\n<li>Arbitrage proof using companies A and B:<\/li>\n<\/ul>\n<p>A B<\/p>\n<p>Net income 1000 1000<\/p>\n<p>Interest at 5% Nil 150<\/p>\n<p>Earnings 1000 850<\/p>\n<p>Divide by cost of equity 10% 11%<\/p>\n<p>MV of equity 10 000 7 727<\/p>\n<p>MV of debt Nil 3 000<\/p>\n<p>Total market value 10 000 10 727<br \/>\n<\/p>\n<p>Essay writing guide: <a href=\"http:\/\/www.aceessays.com\/tc\/\">\u8ad6\u6587\u4ee3\u5beb<\/a><\/p>\n","protected":false},"excerpt":{"rendered":"<p>The traditional approach Ke increases as gearing increases due to rising financial risk and, later, bankruptcy risk. Kd rises at high levels of gearing due to bankruptcy risk. As company starts to replace expensive equity with cheaper debt, WACC falls. As gearing continues to increase, Ke and Kd increase, offsetting the benefit of cheap debt. Net income approach Capital markets are assumed to be perfect. No risk of bankruptcy so Kd curve is flat. Linear increase in Ke due to increasing financial risk. As company gears up and replaces equity with debt, benefit of cheaper debt is exactly balanced by the increasing cost of equity. No optimal capital structure is found. Arbitrage proof using companies A and B: A B Net income 1000 1000 Interest at 5% Nil 150 Earnings 1000 850 Divide by cost of equity 10% 11% MV of equity 10 000 7 727 MV of debt Nil<\/p>\n","protected":false},"author":1,"featured_media":0,"comment_status":"closed","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[22],"tags":[],"class_list":["post-503","post","type-post","status-publish","format-standard","hentry","category-notes"],"_links":{"self":[{"href":"https:\/\/www.aceessays.com\/tc\/wp-json\/wp\/v2\/posts\/503","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/www.aceessays.com\/tc\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/www.aceessays.com\/tc\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/www.aceessays.com\/tc\/wp-json\/wp\/v2\/users\/1"}],"replies":[{"embeddable":true,"href":"https:\/\/www.aceessays.com\/tc\/wp-json\/wp\/v2\/comments?post=503"}],"version-history":[{"count":1,"href":"https:\/\/www.aceessays.com\/tc\/wp-json\/wp\/v2\/posts\/503\/revisions"}],"predecessor-version":[{"id":1528,"href":"https:\/\/www.aceessays.com\/tc\/wp-json\/wp\/v2\/posts\/503\/revisions\/1528"}],"wp:attachment":[{"href":"https:\/\/www.aceessays.com\/tc\/wp-json\/wp\/v2\/media?parent=503"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/www.aceessays.com\/tc\/wp-json\/wp\/v2\/categories?post=503"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/www.aceessays.com\/tc\/wp-json\/wp\/v2\/tags?post=503"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}