The main objective of this chapter is for students to demonstrate that they can identify the manner in which biases impact the decisions that managers make about capital structure, amount of financing, and capital budgeting.

After completing this chapter students will be able to:

1. Describe the evidence that the primary factors that drive managers’ decisions about capital structure are dilution, market timing, and financial flexibility, while traditional considerations such as taxes, costs of financial distress, and information asymmetries are secondary factors.
2. Compute adjusted present value to assess how the managers of a financially constrained firm with undervalued equity should choose between repurchasing shares and undertaking new profitable projects.
3. Explain why concerns about dilution and market timing lead investment policy to be sensitive to cash flows, causing excessively optimistic, overconfident managers of cash rich firms to adopt some negative net present value projects, and excessively optimistic, overconfident managers of cash poor firms to reject some positive net present value projects.
4. Identify excessive optimism and overconfidence in the psychological profile of executives.