Nguyễn Thuỳ Dương 11219679

Trần Hoàng Thái An 11210254

Tạ Hồng Anh 11210741
Phạm Thuỷ Anh 11210716
Nguyễn Phan Trung Hiếu 11212246
Phạm Thế Hưng 11212474
Quách Thị Diễm Quỳnh 11215118
TABLE OF CONTENTS
 1. Definition
2. Importance
1. Definition
1.1. Basic knowledge

combination

•
•

• High D/E ratio

• Low D/E ratio:
 1.2. Examples

conservative
more on equity

financial stability
navigate market uncertainties

Vinamilk’s Capital structure for

Q2/2024

Liabilities Equity
1.2. Examples
higher D/E ratio
HVN’s Capital structure for Q2/2024

capital-intensive
relies on debt
Liabilities Equity
 2. Importance

maximizing shareholder value minimizing risks.

DEBT EQUITY

Cheaper; tax-deductible
ADVANTAGES Not require mandatory payments
-> lower taxable income

Dilutes ownership
Risk of default
DISADVANTAGES -> higher expectations for returns
-> higher costs of borrowing in the future
from shareholders
2. Importance

•
•

DEBT EQUITY
• Raise funds without altering the control structure.
Dilute the ownership stakes of existing
• Burden the company, especially if its cash flows are shareholders
unpredictable.
1. Company life cycle
2. Unique situations
 1. Company life cycle

Business Characteristics
Cash flow
Revenue
growth
Assets
Business
risk
Capital Structure Characteristics
Debt

Equity
2. Unique situations
2.1. Capital - intensive businesses
• high levels of leverage

• Highly capital-intensive businesses

• owned marketing or
service businesses contractual
relationships owners

Hilton Worldwide long-term franchise

management agreements owned by others
 2. Unique situations
2.2. Capital - light businesses

• minimal fixed investments working capital needs

• little debt substantial

net cash
⚬ Positive
⚬ Fast
⚬ Rising increases
1. Internal factors
2. External factors
1. Internal factors
1.1. Business Model Characteristics

• stable revenues and predictable cash flows higher debt levels

• volatile and unpredictable income a lower

level of debt
1. Internal factors
1.1. Business Model Characteristics

𝐹𝐼𝑋𝐸𝐷 𝐶𝑂𝑆𝑇𝑆
𝑂𝑃𝐸𝑅𝐴𝑇𝐼𝑁𝐺 𝐿𝐸𝑉𝐸𝑅𝐴𝐺𝐸 =
𝑇𝑂𝑇𝐴𝐿 𝐶𝑂𝑆𝑇𝑆

• measure business risk

• High operating leverage businesses

airline industry
1. Internal factors
1.1. Business Model Characteristics

Revenue, CF volatility ↑ ↓
Earnings predictability ↑ ↑
Operating leverage ↑ ↓
1. Internal factors
1.1. Business Model Characteristics

Rely on intangible assets (do not have

Definition Own physical, valuable assets
physical form)
ExxonMobil (Oil & Gas) FPT Software (Technology)
Examples Vingroup (Real Estate) Apple (Technology)

Level of debt High Low

Offer lenders security Lack physical form and their value is

Reason Can be sold to recover the loan less predictable
 1. Internal factors
1.1. Business Model Characteristics

Quickly converted
Interchangeable with Take time to convert to
Definition Unique assets to cash without
another of similar identity cash and may lose value.
losing value.
Money Art pieces Cash Real estate

Examples Cash in a bank

A share of Apple stock or A Van Gogh A house or an investment in
account or shares
a government bond. painting. a private business.
of Amazon stock.

Level of debt High Low High Low

1. Internal factors

1.1. Business Model Characteristics

• own their assets outright greater

flexibility

• Asset-light companies:
⚬
⚬
⚬
⚬
1. Internal factors

1.2. Existing leverage

• higher proportions of debt higher

probability of default less ability to service additional debt

• Commonly used ratios include:

 𝐶𝐴
Liquidity Current ratio Ability to meet short-term obligations
𝐶𝐿
↑
Operating How much profit a company makes on a dollar of sales after paying for 𝐸𝐵𝐼𝑇
margin variable costs of production 𝑅𝐸𝑉𝐸𝑁𝑈𝐸
EBITDA How much in earnings a company is generating before interest, taxes, 𝐸𝐵𝐼𝑇𝐷𝐴
Profitability margin depreciation, and amortization, as a % of revenue. 𝑅𝐸𝑉𝐸𝑁𝑈𝐸 ↑
Operating
How much profit a company makes on a dollar of sales after paying for 𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑖𝑛𝑐𝑜𝑚𝑒
income
variable costs of production, but before paying interest or tax. 𝑅𝐸𝑉𝐸𝑁𝑈𝐸
margin
Debt-to- 𝑇𝑜𝑡𝑎𝑙 𝑑𝑒𝑏𝑡 (𝑜𝑟 𝑁𝑒𝑡 𝑑𝑒𝑏𝑡)
How many years it would take for a company to pay back its debt
EBITDA
Leverage
Debt-to- How much debt a company carries compared to the value of the assets it
𝐸𝐵𝐼𝑇𝐷𝐴
𝑇𝐷 ↓
Asset owns. 𝑇𝐴
Interest 𝐸𝐵𝐼𝑇
How well a firm can pay the interest due on outstanding debt.
coverage 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑒𝑥𝑝𝑒𝑛𝑠𝑒
Interest Fixed charge How well a business can pay its fixed expenses, including mandatory debt
coverage coverage payments and interest.
𝐸𝐵𝐼𝑇 + 𝑙𝑒𝑎𝑠𝑒 𝑝𝑎𝑦𝑚𝑒𝑛𝑡𝑠
𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑒𝑥𝑝𝑒𝑛𝑠𝑒 + 𝑙𝑒𝑎𝑠𝑒 𝑝𝑎𝑦𝑚𝑒𝑛𝑡𝑠 ↑
EBITDA-to- 𝐸𝐵𝐼𝑇𝐷𝐴
How easily a firm can pay the interest on its outstanding debt.
interest 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑒𝑥𝑝𝑒𝑛𝑠𝑒
1. Internal factors

1.3. Corporate tax rate

• Interest expense tax-deductible expense
higher tax greater benefit

1.4. Capital structure Policies / Guidelines

• internal capital structure guidelines key ratio, index inclusion
requirements…
1. Internal factors
1.5. Third-party debt ratings
• independent, third-party measures
the company’s ability to pay

↑ ↓ ↑
2. External factors
2.1. Market conditions / Business cycle
• interest rates macroeconomic environment

𝐶𝑂𝑆𝑇 𝑂𝐹 𝐷𝐸𝐵𝑇 = 𝑏𝑒𝑛𝑐ℎ𝑚𝑎𝑟𝑘 𝑟𝑖𝑠𝑘 − 𝑓𝑟𝑒𝑒 𝑟𝑎𝑡𝑒 (𝑟𝑓) + 𝑐𝑜𝑚𝑝𝑎𝑛𝑦 − 𝑠𝑝𝑒𝑐𝑖𝑓𝑖𝑐 𝑐𝑟𝑒𝑑𝑖𝑡 𝑠𝑝𝑟𝑒𝑎𝑑.

•
⚬ expansions
⚬ recessions

=> Companies adjust debt usage based on borrowing costs:

⚬ increase
⚬ reduce
Macroeconomic impact
• COVID-19 pandemic

• Interest rates dropped

credit spreads widened

Company impact
significant
operational losses.
increasing debt levels
decreasing ability to cover interest payments
Pre-Pandemic Position (2018-2019):
•
2018
financial stability.
VNA 2019
Pandemic Impact (2020):
• 2020

2018
financial distress.
• VJ 2019

2020
more manageable level
 2. External factors
2.2. Regulatory constraints 2.3. Industry leverage
• • Companies within the same industry
regulated by government similar capital structures
1. Basic knowledge and application
2. Assumptions
3. Propositions
4. Examples
5. Costs of financial distress
 1. Basic knowledge and application
•

•
⚬
⚬
⚬
⚬
2. Assumptions
•
•
Homogenous expectations
• Investors agree on a given investment’s expected cash flows.

Perfect capital markets

• No transaction costs, no taxes, no bankruptcy costs.
• Everyone has the same information.
Risk-free rate
• Investors can borrow and lend at the risk-free rate.

No agency costs
• Managers always act to maximize shareholder wealth.

Independent decisions
• Financing and investment decisions are independent of each other.
 3. Propositions

Formula 𝑉𝐿 = 𝑉𝑈 𝑉𝐿 = 𝑉𝑈 + 𝑡𝐷

The cash determines firm value flows it

- Increase value by using debt.
generates, with managers being prevented
Implications - Higher the tax rate
from increasing the value of the firm by
- Greater the benefit of using debt
changing the structure of the firm.

“tax shield”

Reasoning Stakeholders
Government
Debt Equity Debt Equity
 3. Propositions

𝐷 𝐷
Formula 𝑟𝑒 = 𝑟0 + (𝑟0 − 𝑟𝑑 ) 𝑟𝑒 = 𝑟0 + (𝑟0 + 𝑟𝑑 )(1 − 𝑡)
𝐸 𝐸
•Cost of equity rises as the company uses more debt
•Higher leverage raises the cost of equity but does not but at a slower rate than in the no-tax case.
change firm value or WACC •As the company’s use of debt increases, its WACC
Implications •The increase in the cost of equity must exactly offset decreases and its value increases.
the greater use of lower-cost debt. •No financial distress/bankruptcy costs, use of debt is
value enhancing, at the extreme, 100% debt is optimal.

•Additional leverage to the company’s capital structure

increases probability of bankruptcy.
•Equity holder will require high return to offset the
Interest is tax-deductible, creating a tax shield that
Reasoning increase in risk.
lowers the cost of debt.
•Adding any amount of low-cost debt into the capital
structure is exactly offset by increase in cost of equity,
hence no change in the company’s value.
4. Examples

Fino company is currently financed by only equity. The company receives an

annual cash flow of USD 10,000 with a cost of equity of 10%
4. Examples

Fino company is currently financed by only equity. The company receives an

annual cash flow of USD 10,000 with a cost of equity of 10%

𝐴𝑛𝑛𝑢𝑎𝑙 𝑓𝑖𝑥𝑒𝑑 𝐶𝐹 10,000

𝑉= = = 𝑈𝑆𝐷 100,000
𝑟𝑊𝐴𝐶𝐶 0.10
4. Examples

Fino company is currently financed by only equity. The company receives an

annual cash flow of USD 10,000 with a cost of equity of 10%

↑ ↓
𝐷 20,000
𝑟𝑒 = 𝑟0 + 𝑟0 − 𝑟𝑑 = 0.1 + 0.1 − 0.05 × = 𝟏𝟏. 𝟐𝟓%
𝐸 80,000
4. Examples

Fino company is currently financed by only equity. The company receives an

annual cash flow of USD 10,000 with a cost of equity of 10%

20,000 80,000
𝑊𝐴𝐶𝐶 = 𝑊𝑑 𝑟𝑑 + 𝑊𝑒 𝑟𝑒 = × 0.05 + × 0.1125 = 10%
100,000 100,000
4. Examples

Fino company is currently financed by only equity. The company receives an

annual cash flow of USD 10,000 with a cost of equity of 10%

1,000 9,000
𝑉 =𝐷+𝐸 = + = 𝑈𝑆𝐷 100,000
0.05 0.1125
4. Examples

EBIT = $6,000 WACC = 12% Debt = $18,000

Cost of debt = 6% Tax rate = 30%
4. Examples

EBIT = $6,000 WACC = 12% Debt = $18,000

Cost of debt = 6% Tax rate = 30%

𝐸𝐵𝐼𝑇(1 − 𝑡) 6,000(1 − 0.30)

𝑉𝑢 = = = $35,000
𝑟𝑊𝐴𝐶𝐶 0.12

𝑉𝐿 = 𝑉𝑈 + 𝑡𝐷 = $35,000 + 0.3 × 18,000 = $40,400

4. Examples

EBIT = $6,000 WACC = 12% Debt = $18,000

Cost of debt = 6% Tax rate = 30%

𝐸 = 𝑉 − 𝐷 = $40,400 − $18,000 = $22,400

𝐷 18,000
𝑟𝑒 = 𝑟0 + 𝑟0 + 𝑟𝑑 1−𝑡 = 0.12 + 0.12 − 0.06 1 − 0.30 × = 0.15375 = 15.38%
𝐸 22,400
4. Examples

EBIT = $6,000 WACC = 12% Debt = $18,000

Cost of debt = 6% Tax rate = 30%

𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑝𝑎𝑦𝑚𝑒𝑛𝑡𝑠 𝑜𝑛 𝑑𝑒𝑏𝑡 (𝐸𝐵𝐼𝑇 − 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡𝑝𝑎𝑦𝑚𝑒𝑛𝑡 𝑜𝑛 𝑑𝑒𝑏𝑡)(1 − 𝑡)

𝑉 =𝐷+𝐸 = +
𝐶𝑜𝑠𝑡 𝑜𝑓 𝑑𝑒𝑏𝑡 𝐶𝑜𝑠𝑡 𝑜𝑓 𝐸𝑞𝑢𝑖𝑡𝑦
0.06 × 18,000 (6,000 − 1,080)(1 − 0.3)
= + = $40,400
0.06 0.15375
4. Examples

EBIT = $6,000 WACC = 12% Debt = $18,000

Cost of debt = 6% Tax rate = 30%

𝐷 𝐸 18,000 22,400
𝑟𝑊𝐴𝐶𝐶 = 𝑟𝑑 1 − 𝑡 + 𝑟𝑒 = × 0.06 × 1 − 0.3 + × 0.15375 = 10.39%
𝑉 𝑉 40,400 40,400

6,000(1 − 0.30)
𝑉𝐿 = = $40,400
0.1039
5. Costs of Financial distress

heightened uncertainty
various obligations diminished earnings power actual current losses.

• increased costs earnings decline

point trouble paying fixed financing costs

• two components

𝐸𝑋𝑃𝐸𝐶𝑇𝐸𝐷 𝐶𝑂𝑆𝑇 = 𝐶𝑜𝑠𝑡 𝑜𝑓 𝑓𝑖𝑛𝑎𝑛𝑐𝑖𝑎𝑙 𝑑𝑖𝑠𝑡𝑟𝑒𝑠𝑠 𝑎 × 𝑃𝑟𝑜𝑏𝑎𝑏𝑖𝑙𝑖𝑡𝑦 𝑜𝑓 𝑓𝑖𝑛𝑎𝑛𝑐𝑖𝑎𝑙 𝑑𝑖𝑠𝑡𝑟𝑒𝑠𝑠 (𝑏)

5. Costs of Financial distress
5.1. Costs of Financial Distress and Bankruptcy

Include actual cash expenses associated with the bankruptcy process:

Direct
o Legal fees
cost
o Administrative fees

Include costs arising during periods in which the company is near or in bankruptcy:
o Forgone investment opportunities
Indirect o Reputational risk
cost o Impaired ability to conduct business
o Costs arising from conflicts of interest between managers and debtholders
(agency costs of debt)
5. Costs of Financial distress
5.2. Probability of Financial distress

• firm’s use of operating financial leverage

•
⚬ greater debt
⚬ greater business risk
⚬

•
⚬ corporate governance structure
⚬ quality management team.

Higher expected costs of financial distress discourage using large

proportions of debt
 1. Static trade-off theory
2. Market value vs. Book value
3. Target weights and WACC
4. Pecking order theory
1. Static Trade-off theory
• optimal capital structure tax shield benefits costs of
financial distress.

• Maximizes firm value

𝑉𝐿 = 𝑉𝑈 + 𝑡𝐷 − 𝑃𝑉 (Cost of financial distress)

o 𝑉𝐿

o 𝑉𝑈

o 𝑡

o 𝑡𝐷

o 𝑃𝑉
1. Static Trade-off theory

MM (With taxes) 𝑽𝑳 = 𝑽𝑼 + 𝒕𝑫

↑ with
↑ leverage
𝑽𝑳 = 𝑽𝑼 + 𝒕𝑫
Static Trade-off −𝑷𝑽 (𝒄𝒐𝒔𝒕 𝒐𝒇 𝒇𝒊𝒏𝒂𝒏𝒄𝒊𝒂𝒍 𝒅𝒊𝒔𝒕𝒓𝒆𝒔𝒔)

MM (No taxes) 𝑽𝑳 = 𝑽𝑼

𝑀𝑎𝑟𝑔𝑖𝑛𝑎𝑙 𝑖𝑛𝑐𝑟𝑒𝑎𝑠𝑒 𝑖𝑛 𝑃𝑉 𝑜𝑓 𝑡𝑎𝑥 𝑠ℎ𝑖𝑒𝑙𝑑 = 𝑀𝑎𝑟𝑔𝑖𝑛𝑎𝑙 𝑖𝑛𝑐𝑟𝑒𝑎𝑠𝑒 𝑖𝑛 𝑃𝑉 𝑜𝑓 𝑓𝑖𝑛𝑎𝑛𝑐𝑖𝑎𝑙 𝑑𝑖𝑠𝑡𝑟𝑒𝑠𝑠 𝑐𝑜𝑠𝑡𝑠

1. Static Trade-off theory

• ideal mix of debt and equity minimizes the

cost of capital.

• trade-off
⚬ Leverage benefits:
⚬ Leverage risks
1. Static Trade-off theory

• practical application

• a range of debt levels

⚬
⚬
⚬

• Actual differ from the target

⚬
⚬
⚬
2. Market value vs. Book value

recorded on the
Current
balance sheet
determined by the market

Optimal Target
2. Market value vs. Book value

•
3. Target weight & WACC
•
maintain
over the long term
𝑇𝑜𝑡𝑎𝑙 𝐷𝑒𝑏𝑡
𝐷𝑒𝑏𝑡 − 𝑡𝑜 − 𝐸𝑞𝑢𝑖𝑡𝑦 𝑟𝑎𝑡𝑖𝑜 =
𝑇𝑜𝑡𝑎𝑙 𝐸𝑞𝑢𝑖𝑡𝑦

•
𝐷𝑒𝑏𝑡
𝑊𝑑 =
𝐷𝑒𝑏𝑡+𝐸𝑞𝑢𝑖𝑡𝑦

Example
𝐸𝑞𝑢𝑖𝑡𝑦
𝑊𝑒 = 1 − 𝑊𝑑 =
𝐷𝑒𝑏𝑡 + 𝐸𝑞𝑢𝑖𝑡𝑦
3. Target weight & WACC

𝐸 𝐷
𝑊𝐴𝐶𝐶 = × 𝑟𝑒 + × 𝑟𝑑 × (1 − 𝑇𝐶 )
𝑉 𝑉

𝐸 𝐷
o o
𝑉 𝑉

o 𝑟𝑒 o 𝑟𝑑

o 𝑇𝐶
 Assume Vinamilk:
• Equity: $70 billion Debt: $30 billion
3. Target weight & WACC
• Cost of equity 7% Cost of debt 3%
• Tax rate 20%

𝑇𝑜𝑡𝑎𝑙 𝐷𝑒𝑏𝑡
𝐷𝑒𝑏𝑡 − 𝑡𝑜 − 𝐸𝑞𝑢𝑖𝑡𝑦 𝑟𝑎𝑡𝑖𝑜 = 30 30
𝑇𝑜𝑡𝑎𝑙 𝐸𝑞𝑢𝑖𝑡𝑦 Weight of Debt: 𝑊𝑑 = = = 𝟎. 𝟑𝟎
30 + 70 100
𝐷𝑒𝑏𝑡 70 70
𝑊𝑑 = Weight of Equity: 𝑊𝑒 = = = 𝟎. 𝟕𝟎
𝐷𝑒𝑏𝑡+𝐸𝑞𝑢𝑖𝑡𝑦 70 + 30 100

𝐸𝑞𝑢𝑖𝑡𝑦 WACC:
𝑊𝑒 = 1 − 𝑊𝑑 =
𝐷𝑒𝑏𝑡 + 𝐸𝑞𝑢𝑖𝑡𝑦
= 0.70 × 0.07 + 0.30 × 0.03 × 1 − 0.20
= 0.049 + 0.30 × 0.03 × 0.80
𝐸 𝐷
𝑊𝐴𝐶𝐶 = × 𝑟𝑒 + × 𝑟𝑑 × (1 − 𝑇𝐶 ) = 0.049 + 0.0072
𝑉 𝑉 = 𝟎. 𝟎𝟓𝟔𝟐 𝒐𝒓 𝟓. 𝟔𝟐%
 4. Pecking order theory

o A similar principle can be applied

to the whole economy. It can
also be the specialization and
division of knowledge, like a
broker who has asymmetric
information over a buyer.

o Asymmetric information, can be

beneficial to a society in
increasing efficiency.
4. Pecking order theory

=> Thus, the cheapest financing source is retained earnings, followed by debt, and then equity.

Internal Financing →
Debt Financing →
Equity Financing →
1. Debtholders and Shareholders
2. Preferred Shareholders
3. Management and Directors
1. Debtholders and Shareholders
1.1. General idea

Means of interests

Priorities

Strategies
1. Debtholders and Shareholders
1.2. Conflicts

• •
•
• •
•
1. Debtholders and Shareholders
1.2. Conflicts

•
•
•
1. Debtholders and Shareholders
1.2. Conflicts

•
⚬
⚬
•
2. Preferred Shareholders

2.1. Advantages over Commoners

•

2.2. Disadvantages
•

•
3. Management and Directors

• •

•
 3. Management and Directors

Monitoring
costs

Bonding
costs

Residual loss

Incentive
mechanism

Corporate
governance

Agency cost across different types of organizations:

o non-profit organizations

o governmental agencies