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The Leverage Factor

TABLE OF CONTENTS
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1. - Introduction: A Tale of Two Companies, or three, or four... 1
SECTION 1: THE THEORY OF CAPITAL STRUCTURE 11
2. - Leverage 11
Business Risk, 12
Financial Risk, 13
Leverage: A Definition, 13
Basic Risks and Proportions, 14
Balancing Leverage, 16
The Anatomy of Financial Leverage, 17
The Anatomy of Operating leverage, 20
Total Risk, 22
Leverage Measurement, 23
Theory vs. Reality: Financial Leverage, 24
Theory vs. Reality: Operating Leverage, 24
Theory and Reality: Total Leverage, 25
Leverage Management, 27
Sources of Variation, 28
Return on Equity, 30,
The Forces Behind Leverage, 31
Appendix: Streamlining?, 33
3. - Capital Structure 35
The Cost of Capital: Market Orientation and Practical Application, 36
The Advantages of Debt, 38
Risk and Debt, 40
Mathematical Optimization: Theory vs. Reality, 43
The Modigliani - Miller Propositions, 45
The Optimization Problem, 46
The Proposed Ideal and its Inherent Problems, 48
Capital Structure and the Cost of Capital, 50
The Concept of a Weighted Average Cost of Capital, 53
Earnings and Capital Structure, 55
Capital Structure Logic, 56
Changes in Capital Structure and Stock Prices, 57
Four “Postulates”, 59
Share Limitations, 60
Adapted Measurements, 61
Explicit vs. Implicit Costs, 62
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