Introduction to Finance

LO 18.8 
Several fi ndings of theoretical and empirical studies indicate 
a broad number of infl uences on a fi rm’s capital structure decision. 
These include management’s desire to balance the benefi ts and draw-
backs of debt, fi nancing pecking orders (to fi nance fi rm expansion, 
managers prefer to use additions to retained earnings, then to issue 
debt, and fi nally to issue new shares of stock), market timing (issue 
stock when share prices are high), and agency cost issues, among 
others.
Key Terms
bankruptcy costs
business risk
capital structure
combined leverage
cost of capital
degree of combined leverage 
(DCL)
degree of fi nancial leverage (DFL)
dividend payout ratio
EBIT/eps analysis
fl otation costs
internal growth rate
market timing hypothesis
optimum debt/equity mix
pecking order hypothesis
retention rate
static trade-off hypothesis
sustainable growth rate
weighted average cost of capital 
(WACC)
Review Questions
 1. 
(LO 18.1)
What is a fi rm’s capital structure?
 2. 
(LO 18.1)
Explain why determining a fi rm’s optimum debt/equity 
mix is important.
 3. 
(LO 18.1)
Briefl y describe the trends that have occurred in the 
corporate use of debt.
 4. 
(LO 18.1)
How have the Fed’s policies since the 2007–2009 Great 
Recession aff ected corporate fi nancing decisions?
 5. 
(LO 18.1)
How did the Fed’s loose money policies after the 
2007–2009 Great Recession aff ect investors?
 6. 
(LO 18.1)
Following the Fed’s eff orts to lower interest rates, what 
actions by investors increased their potential exposure to risk?
 7. 
(LO 18.2)
What is the relationship between a fi rm’s cost of capital 
and investor required rates of return?