TAILIEUCHUNG - Ebook Corporate finance (11th edition): Part 2
(BQ) Part 1 book "Corporate finance" has contents: Valuation and capital budgeting for the levered firm, dividends and other payouts, options and corporate finance, international corporate finance, financial distress, credit and inventory management, cash management,.and other contents. | 17 Capital Structure LIMITS TO THE USE OF DEBT March 2014 was a tough month for fast food. First, on March 10, mall and airport pizza company Sbarro announced it was filing for bankruptcy. The company stated that foot traffic in malls had dropped in recent years. This fact, coupled with the company’s debt, meant management was forced to turn to bankruptcy. This filing was Sbarro’s second bankruptcy in three years. It had filed for bankruptcy in April 2011, emerging in November 2011. Also in March 2014, sub chain Quiznos announced that it would be toasted without a bankruptcy filing. At one point, the company had more than 5,000 restaurants, but as rival Subway grew, the number of Quiznos stores dropped to 2,100. Women’s clothing retailers also faced problems in 2014 as both Coldwater Creek and Dots were forced to file bankruptcy. As these situations point out, there is a limit to the financial leverage a company can use, and the risk of too much leverage is bankruptcy. In this chapter, we discuss the costs associated with bankruptcies and how companies attempt to avoid this unhappy outcome. The previous chapter began with the question, “How should a firm choose its debt–equity ratio?” We first presented the Modigliani-Miller (MM) result that, in a world without taxes, the value of the levered firm is the same as the value of the unlevered firm. In other words, the choice of the debt–equity ratio is unimportant here. We next showed the MM result that, in a world with corporate taxes, the value of the firm increases with leverage, implying that firms should take on as much debt as possible. But this result leaves one with a number of questions. Is this the whole story? Should financial managers really set their firms’ debt-to-value ratios near 100 percent? If so, why do real-world companies have, as we show later in this chapter, rather modest levels of debt? The current chapter bridges the gap between theory and practice. We show that .
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