Chapter 14
Capital Structure in a Perfect Market
I. Chapter Outline
The following chapter outline is correlated to the PowerPoint Lecture Slides. The PowerPoint slides
are referenced in bold. Alternative Examples to selected textbook examples are also available in the
PowerPoint Lecture Slides and are also referenced in bold.
14.1 Equity Versus Debt Financing (Slide 7)
• Financing a Firm with Equity (Slides 8–15)
• Table 14.1 The Project Cash Flows (Slide 9)
• Table 14.2 Cash Flows and Returns for Unlevered Equity (Slide 14)
• Table 14.4 Returns to Equity with and without Leverage (Slide 24)
• Table 14.5 Systematic Risk and Risk Premiums for Debt, Unlevered Equity, and Levered
Equity (Slide 27)
• Example 14.1 Leverage and the Equity Cost of Capital (Slides 31–32)
• PowerPoint Alternative Example 14.1 (Slides 33–35)
14.2 Modigliani-Miller I: Leverage, Arbitrage, and Firm Value (Slides 36–38)
• MM and the Law of One Price (Slide 39)
• Homemade Leverage (Slides 40–46)
• Table 14.6 Replicating Levered Equity Using Homemade Leverage (Slide 42)
• Table 14.7 Replicating Levered Equity by Holding Debt and Equity (Slide 45)
• Example 14.2 Homemade Leverage and Arbitrage (Slides 47-48)
• PowerPoint Alternative Example 14.2 (Slides 49–52)
• The Market Value Balance Sheet (Slides 53-55)
• Table 14.8 The Market Value Balance Sheet of the Firm (Slide 54)
• Table 14.9 Market Value Balance Sheet after Each Stage of Harrison’s Leveraged
Recapitalization (in $ million) (Slide 63)
14.3 Modigliani-Miller II: Leverage, Risk, and the Cost of Capital (Slide 68)
• Leverage and the Equity Cost of Capital (Slides 69–76)
• Example 14.4 Computing the Equity Cost of Capital (Slides 77–78)
• PowerPoint Alternative Example 14.4 (Slides 79–80)
Berk/DeMarzo • Corporate Finance, Fourth Edition, Global Edition 61
• Capital Budgeting and the Weighted Average Cost of Capital (Slides 81–85)
• Figure 14.1 WACC and Leverage with Perfect Capital Markets (Slide 84)
• Example 14.5 Reducing Leverage and the Cost of Capital (Slides 86–87)
• PowerPoint Alternative Example 14.5 (Slides 88–91)
• Common Mistake: Is Debt Better Than Equity?
14.4 Capital Structure Fallacies (Slides 102–107)
• Leverage and Earnings per Share (Slides 102–106)
14.5 MM: Beyond the Propositions (Slide 116)
II. Learning Objectives
14-2 Describe the capital structure that the firm should choose.
14-4 Discuss the implications of MM Proposition I and the roles of homemade leverage and the
Law of One Price in the development of the proposition.
14-6 Illustrate the effect of a change in debt on weighted average cost of capital in perfect capital
markets.
14-8 Illustrate the effect of increased leverage on the beta of a firm’s equity.
14-10 Discuss the effect of leverage on a firm’s expected earnings per share.
14-12 Explain why perfect capital markets neither create nor destroy value.
III. Chapter Overview
In this chapter, the capital structure decision is examined in a setting of perfect capital markets in
which all securities are fairly priced, there are no taxes or transactions costs, and the total cash flows
of the firm’s projects are not affected by how the firm finances them.
