Definition of Pie model of capital structure

Pie model of capital structure

A model of the debt/equity ratio of the firms, graphically depicted in slices of
a pie that represent the value of the firm in the capital markets.

economic components model

Abrams’ model for calculating DLOM based on the interaction of discounts from four economic components.
This model consists of four components: the measure of the economic impact of the delay-to-sale, monopsony power to buyers, and incremental transactions costs to both buyers and sellers.

Gordon model

present value of a perpetuity with growth.
The end-ofyear Gordon model formula is: 1/(r - g)
and the midyear formula is: SQRT(1 + r)/(r - g).

log size model

Abrams’ model to calculate discount rates as a function of the logarithm of the value of the firm.

QMDM (quantitative marketability discount model)

model for calculating DLOM for minority interests r the discount rate

Arbitrage-free option-pricing models

Yield curve option-pricing models.

Asset pricing model

A model for determining the required rate of return on an asset.

Asset pricing model

A model, such as the capital Asset Pricing model (CAPM), that determines the required
rate of return on a particular asset.

Average cost of capital

A firm's required payout to the bondholders and to the stockholders expressed as a
percentage of capital contributed to the firm. Average cost of capital is computed by dividing the total
required cost of capital by the total amount of contributed capital.

Binomial option pricing model

An option pricing model in which the underlying asset can take on only two
possible, discrete values in the next time period for each value that it can take on in the preceding time period.

Black-Scholes option-pricing model

A model for pricing call options based on arbitrage arguments that uses
the stock price, the exercise price, the risk-free interest rate, the time to expiration, and the standard deviation
of the stock return.

Capital

Money invested in a firm.

Capital account

Net result of public and private international investment and lending activities.

Capital allocation

decision Allocation of invested funds between risk-free assets versus the risky portfolio.

Capital asset pricing model (CAPM)

An economic theory that describes the relationship between risk and
expected return, and serves as a model for the pricing of risky securities. The CAPM asserts that the only risk
that is priced by rational investors is systematic risk, because that risk cannot be eliminated by diversification.
The CAPM says that the expected return of a security or a portfolio is equal to the rate on a risk-free security
plus a risk premium.

Capital budget

A firm's set of planned capital expenditures.

Capital budgeting

The process of choosing the firm's long-term capital assets.

Capital expenditures

Amount used during a particular period to acquire or improve long-term assets such as
property, plant or equipment.

Capital flight

The transfer of capital abroad in response to fears of political risk.

Capital gain

When a stock is sold for a profit, it's the difference between the net sales price of securities and
their net cost, or original basis. If a stock is sold below cost, the difference is a capital loss.

Capital gains yield

The price change portion of a stock's return.

Capital lease

A lease obligation that has to be capitalized on the balance sheet.

Capital loss

The difference between the net cost of a security and the net sale price, if that security is sold at a loss.

Capital market

The market for trading long-term debt instruments (those that mature in more than one year).

Capital market efficiency

Reflects the relative amount of wealth wasted in making transactions. An efficient
capital market allows the transfer of assets with little wealth loss. See: efficient market hypothesis.

Capital market imperfections view

The view that issuing debt is generally valuable but that the firm's
optimal choice of capital structure is a dynamic process that involves the other views of capital structure (net
corporate/personal tax, agency cost, bankruptcy cost, and pecking order), which result from considerations of
asymmetric information, asymmetric taxes, and transaction costs.

Capital market line (CML)

The line defined by every combination of the risk-free asset and the market portfolio.

Capital rationing

Placing one or more limits on the amount of new investment undertaken by a firm, either
by using a higher cost of capital, or by setting a maximum on parts of, and/or the entirety of, the capital
budget.

Capital structure

The makeup of the liabilities and stockholders' equity side of the balance sheet, especially
the ratio of debt to equity and the mixture of short and long maturities.

Capital surplus

Amounts of directly contributed equity capital in excess of the par value.

Capitalization

The debt and/or equity mix that fund a firm's assets.

Capitalization method

A method of constructing a replicating portfolio in which the manager purchases a
number of the largest-capitalized names in the index stock in proportion to their capitalization.

Capitalization ratios

Also called financial leverage ratios, these ratios compare debt to total capitalization
and thus reflect the extent to which a corporation is trading on its equity. capitalization ratios can be
interpreted only in the context of the stability of industry and company earnings and cash flow.

Capitalization table

A table showing the capitalization of a firm, which typically includes the amount of
capital obtained from each source - long-term debt and common equity - and the respective capitalization
ratios.

Capitalized

Recorded in asset accounts and then depreciated or amortized, as is appropriate for expenditures
for items with useful lives greater than one year.

Capitalized interest

Interest that is not immediately expensed, but rather is considered as an asset and is then
amortized through the income statement over time.

Complete capital market

A market in which there is a distinct marketable security for each and every
possible outcome.

Constant-growth model

Also called the Gordon-Shapiro model, an application of the dividend discount
model which assumes (1) a fixed growth rate for future dividends and (2) a single discount rate.

Cost of capital

The required return for a capital budgeting project.

Cost of limited partner capital

The discount rate that equates the after-tax inflows with outflows for capital
raised from limited partners.

Dedicated capital

Total par value (number of shares issued, multiplied by the par value of each share). Also
called dedicated value.

Deterministic models

Liability-matching models that assume that the liability payments and the asset cash
flows are known with certainty. Related: Compare stochastic models

Discounted dividend model (DDM)

A formula to estimate the intrinsic value of a firm by figuring the
present value of all expected future dividends.

Dividend discount model (DDM)

A model for valuing the common stock of a company, based on the
present value of the expected cash flows.

Dividend growth model

A model wherein dividends are assumed to be at a constant rate in perpetuity.

Efficient capital market

A market in which new information is very quickly reflected accurately in share
prices.

Extrapolative statistical models

models that apply a formula to historical data and project results for a
future period. Such models include the simple linear trend model, the simple exponential model, and the
simple autoregressive model.

Factor model

A way of decomposing the factors that influence a security's rate of return into common and
firm-specific influences.

Garmen-Kohlhagen option pricing model

A widely used model for pricing foreign currency options.

Hard capital rationing

capital rationing that under no circumstances can be violated.

Human capital

The unique capabilities and expertise of individuals.

Index model

A model of stock returns using a market index such as the S&P 500 to represent common or
systematic risk factors.

Issued share capital

Total amount of shares that are in issue. Related: outstanding shares.

Legal capital

Value at which a company's shares are recorded in its books.

Liquidity theory of the term structure

A biased expectations theory that asserts that the implied forward
rates will not be a pure estimate of the market's expectations of future interest rates because they embody a
liquidity premium.

Long-term debt/capitalization

Indicator of financial leverage. Shows long-term debt as a proportion of the
capital available. Determined by dividing long-term debt by the sum of long-term debt, preferred stock and
common stockholder equity.

Market capitalization

The total dollar value of all outstanding shares. Computed as shares times current
market price. It is a measure of corporate size.

Market capitalization rate

Expected return on a security. The market-consensus estimate of the appropriate
discount rate for a firm's cash flows.

Market model

This relationship is sometimes called the single-index model. The market model says that the
return on a security depends on the return on the market portfolio and the extent of the security's
responsiveness as measured, by beta. In addition, the return will also depend on conditions that are unique to
the firm. Graphically, the market model can be depicted as a line fitted to a plot of asset returns against
returns on the market portfolio.

Modeling

The process of creating a depiction of reality, such as a graph, picture, or mathematical
representation.

Net working capital

Current assets minus current liabilities. Often simply referred to as working capital.

Nondiversifiability of human capital

The difficulty of diversifying one's human capital (the unique
capabilities and expertise of individuals) and employment effort.

Opportunity cost of capital

Expected return that is foregone by investing in a project rather than in
comparable financial securities.

Other capital

In the balance of payments, other capital is a residual category that groups all the capital
transactions that have not been included in direct investment, portfolio investment, and reserves categories. It
is divided into long-term capital and short-term capital and, because of its residual status, can differ from
country to country. Generally speaking, other long-term capital includes most non-negotiable instruments of a
year or more like bank loans and mortgages. Other short-term capital includes financial assets of less than a
year such as currency, deposits, and bills.

Outstanding share capital

Issued share capital less the par value of shares that are held in the company's treasury.

Pecking-order view (of capital structure)

The argument that external financing transaction costs, especially
those associated with the problem of adverse selection, create a dynamic environment in which firms have a
preference, or pecking-order of preferred sources of financing, when all else is equal. Internally generated
funds are the most preferred, new debt is next, debt-equity hybrids are next, and new equity is the least
preferred source.

Perfect capital market

A market in which there are never any arbitrage opportunities.

Perfect market view (of capital structure)

Analysis of a firm's capital structure decision, which shows the
irrelevance of capital structure in a perfect capital market.

Personal tax view (of capital structure)

The argument that the difference in personal tax rates between
income from debt and income from equity eliminates the disadvantage from the double taxation (corporate
and personal) of income from equity.

Planned capital expenditure program

capital expenditure program as outlined in the corporate financial plan.

Pro forma capital structure analysis

A method of analyzing the impact of alternative capital structure
choices on a firm's credit statistics and reported financial results, especially to determine whether the firm will
be able to use projected tax shield benefits fully.

Real capital

Wealth that can be represented in financial terms, such as savings account balances, financial
securities, and real estate.

Single factor model

A model of security returns that acknowledges only one common factor.
See: factor model.

Single index model

A model of stock returns that decomposes influences on returns into a systematic factor,
as measured by the return on the broad market index, and firm specific factors.

Simple linear trend model

An extrapolative statistical model that asserts that earnings have a base level and
grow at a constant amount each period.

Single-index model

Related: market model

"Soft" Capital Rationing

capital rationing that under certain circumstances can be violated or even viewed
as made up of targets rather than absolute constraints.

Static theory of capital structure

Theory that the firm's capital structure is determined by a trade-off of the
value of tax shields against the costs of bankruptcy.

Stochastic models

Liability-matching models that assume that the liability payments and the asset cash flows
are uncertain. Related: Deterministic models.

Structured arbitrage transaction

A self-funding, self-hedged series of transactions that usually utilize
mortgage securities as the primary assets.

Structured debt

Debt that has been customized for the buyer, often by incorporating unusual options.

Structured portfolio strategy

A strategy in which a portfolio is designed to achieve the performance of some
predetermined liabilities that must be paid out in the future.

Structured settlement

An agreement in settlement of a lawsuit involving specific payments made over a
period of time. Property and casualty insurance companies often buy life insurance products to pay the costs
of such settlements.

Two-factor model

Black's zero-beta version of the capital asset pricing model.

Two-state option pricing model

An option pricing model in which the underlying asset can take on only two
possible (discrete) values in the next time period for each value it can take on in the preceding time period.
Also called the binomial option pricing model.

Value-at-Risk model (VAR)

Procedure for estimating the probability of portfolio losses exceeding some
specified proportion based on a statistical analysis of historical market price trends, correlations, and volatilities.

Venture capital

An investment in a start-up business that is perceived to have excellent growth prospects but
does not have access to capital markets. Type of financing sought by early-stage companies seeking to grow rapidly.

Weighted average cost of capital

Expected return on a portfolio of all the firm's securities. Used as a hurdle
rate for capital investment.

Working capital

Defined as the difference in current assets and current liabilities (excluding short-term
debt). Current assets may or may not include cash and cash equivalents, depending on the company.

Working capital management

The management of current assets and current liabilities to maximize shortterm liquidity.

Working capital ratio

Working capital expressed as a percentage of sales.

Yield curve option-pricing models

models that can incorporate different volatility assumptions along the
yield curve, such as the Black-Derman-Toy model. Also called arbitrage-free option-pricing models.

CAPITAL

The money, raised by selling stock or bonds or taking out loans, that you use to start, operate, and grow a business.

CAPITAL IN EXCESS OF PAR VALUE

What a company collected when it sold stock for more than the par value per share.

Capital

The shareholders’ investment in the business; the difference between the assets and liabilities
of a business.

Capital employed

The total of debt and equity, i.e. the total funds in the business.

Capitalize

To make a payment that might otherwise be an expense (in the Profit and Loss account) an asset
(in the Balance Sheet).

Capital market

The market in which investors buy and sell shares of companies, normally associated with a Stock Exchange.

Cost of capital

The costs incurred by an organization to fund all its investments, comprising the risk-adjusted
cost of equity and debt weighted by the mix of equity and debt.

Return on capital employed (ROCE)

The operating profit before interest and tax as a percentage of the total shareholders’ funds plus
the long-term debt of the business.

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