Introduction to Finance

Financial Economics Network. Another site, http://www.cfo.com, contains items of 
interest on fi nancing and other corporate fi nance topics.
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Securities can reduce the adverse eff ects of price swings that might contribute to business risk. Bonds with coupons 
that rise and fall with changes in commodity prices, market interest rates, or foreign currencies can mitigate the eff ects 
of EBIT variations on net income. Firms can reduce political risk exposure from their foreign operations by fi nancing 
foreign assets with host country bank loans or debt issues.

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C H A PT E R 1 8 Capital Structure and The Cost of Capital
Applying Finance To...
• Institutions and Markets 
A fi rm’s capital structure is aff ected by 
the costs it faces from raising capital. Depository institutions and 
investment banks funnel savings to those wanting to raise funds. They 
do so in a way that lowers fl otation and other transactions costs asso-
ciated with raising funds, thereby making it easier for fi rms to raise 
capital. Security analysts and bond rating agencies convey opinions to 
investors regarding the attractiveness of a fi rm’s securities.
• Investments 
Dividends and the price appreciation potential in 
equity are attractive to many investors. Investors examine a fi rm’s 
prospects and “vote with their dollars” by deciding which invest-
ments look most attractive from a risk/expected return trade-off . The 
market prices of a fi rm’s securities and the ratings (given the fi rm’s 
bonds) are used as inputs into the fi rm’s decision-making process, 
because they determine the cost of fi nancing the fi rm’s assets. There-
fore, they are a cost the fi rm must consider in its capital budgeting 
decisions.
• Financial Management
Financial managers need to listen to the 
market. Trends in interest rates will aff ect the fi rm’s choice of short-
term and long-term borrowing. Changes in stock prices that diff er 
from those of the overall market or the fi rm’s industry group send 
positive or negative messages to managers about how investors eval-
uate the fi rm’s future prospects. Financial capital is expensive; the 
cost of fi nancing assets, whether in the form of higher inventory or 
equipment, must be part of the fi rm’s investment decisions.
Summary