capital structure limits to the use of debt

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1、CHAPTER16CapitalStructureLimitstotheUseofDebtAirlineshavetraditionallyreliedheavilyontheuseof$1.2billioninthefourthquarter,andenteredbankruptcyfinancialleverage.Unfortunately,thispracticecanhaveinSeptember2005.NorthwestAirlines,alsofacinghugeadverseconsequenceswhenthingsdon’tworkoutasloss

2、es,filedatthesametimeasDelta.Inbothcases,itplanned,astheairlineindustryhasplainly(andpainfully)islikelytobesometimebeforethecompaniesemergeshowed.Forexample,onFebruary1,2006,UnitedAirlinesfromthebankruptcyprocess.Inearly2006,anotherfiveemergedfromChapter11bankruptcyafterspendingsmallerairl

3、ineswerealsoinbankruptcy.38monthsinthebankruptcyprocess.EventhoughtheAsthesesituationspointout,thereisalimittothecompanyreorganizeditsbalancesheet,itstillfacedprob-financialleverageacompanycanundertake,andthelems.During2005,Unitedpostedalossof$741million,riskoftoomuchleverageisbankruptcy.

4、Inthischapter,anditslossinthefourthquarteroftheyearwasits22ndwediscussthecostsassociatedwithbankruptciesandconsecutivequarterwithredink.howcompaniesattempttoavoidthisprocess.Ofcourse,otherbigairlineswerestillinbankruptcy.DeltaAirLineslost$3.8billionin2005,including16.1CostsofFinancialDis

5、tressBankruptcyRiskorBankruptcyCost?Asmentionedthroughoutthepreviouschapter,debtprovidestaxbenefitstothefirm.How-ever,debtputspressureonthefirmbecauseinterestandprincipalpaymentsareobliga-tions.Iftheseobligationsarenotmet,thefirmmayrisksomesortoffinancialdistress.Theultimatedistressisbankrupt

6、cy,whereownershipofthefirm’sassetsislegallytransferredfromthestockholderstothebondholders.Thesedebtobligationsarefundamentallydif-ferentfromstockobligations.Althoughstockholderslikeandexpectdividends,theyarenotlegallyentitledtodividendsinthewaybondholdersarelegallyentitledtointerestandpri

7、ncipalpayments.Weshownextthatbankruptcycosts,ormoregenerallyfinancialdistresscosts,tendtooffsettheadvantagestodebt.Webeginbypositingasimpleexampleofbankruptcy.Alltaxesareignoredtofocusonlyonthecostsofdebt.455ros05902_ch16.indd4559/25/0611:20:27AM456PartIVCapitalStructurean