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Principles of Finance

Key Terms

Principles of FinanceKey Terms
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after-tax cost of debt
the net cost of interest on a company’s debt after taxes; the firm’s effective cost of debt
capital
a company’s sources of financing
capital structure
the percentages of a company’s assets that are financed by debt capital, preferred stock capital, and common stock capital
conversion price
the face value of a convertible bond divided by its conversion ratio
conversion ratio
the number of shares of common stock receivable for each convertible bond that is converted
convertible bonds
bonds that can be converted into a fixed number of shares of common stock upon maturity
financial distress
when a firm has trouble meeting debt obligations
financial leverage
the debt used in a company’s capital structure
flotation costs
costs involved in the issuing and placing of new securities
interest tax shield
the reduction in taxes paid because interest payments on debt are a tax-deductible expense; calculated as the corporate tax rate multiplied by interest payments
levered equity
equity in a firm that has debt outstanding
net debt
a company’s total debt minus any cash or risk-free assets the company holds
preferred stock
equity capital that has a fixed dividend; preferred shareholders fall in between debt holders and common stockholders in the order of claimants
trade-off theory
a theory stating that the total value of a levered company is the value of the firm without leverage plus the value of the interest tax shield less financial distress costs
unlevered equity
equity in a firm that has no debt outstanding
weighted average cost of capital (WACC)
the average of a firm’s debt and equity costs of capital, weighted by the fractions of the firm’s value that correspond to debt and equity
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