Chapter+14capstructure5-30财务管理.ppt

14-1 CHAPTER 14 Capital Structure and Leverage nBusiness vs. financial risk nOperating leverage nOptimal Capital structure 14-2 nUncertainty about future operating income (EBIT), i.e., how well can we predict operating income? nNote that business risk does not include financing effects. What is business risk? Probability EBITE(EBIT)0 Low risk High risk 14-3 Operating Leverage nThe extent to which fixed costs are used in a firms operations nExample: Price = $5 nPlan As variable cost = $2.5 and fixed cost = $2,000 nPlan Bs variable cost = $3.5 and fixed cost = $600 nEBIT = PQ - VQ F nBreakeven quantity of n A = 5Q - 2.5Q - 2000 = 0 = Q = 800 n B = 5Q 3.5Q 600 = 0 = Q = 400 14-4 Operating Leverage nPlan A and Plan B will have the same EBIT if n5Q 2.5Q -2000 = 5Q 3.5Q -600 n= Q = 1400 n0 399 Both incur loss. n401 799 Only B is profitable. n801 1399 Both are profitable but B is better. n1400 Both have the same profit. n1401 A is better. 14-5 Effect of operating leverage nMore operating leverage leads to more business risk, for then a small sales decline causes a big profit decline. Sales $ Rev. TC FC QBESales $ Rev. TC FC QBE Profit 14-6 Using operating leverage nTypical situation: Can use operating leverage to get higher E(EBIT), but risk also increases. Probability EBITL Low operating leverage High operating leverage EBITH 14-7 What is financial leverage? Financial risk? nFinancial leverage is the use of debt. nFinancial risk is the additional risk concentrated on common stockholders as a result of financial leverage. 14-8 An example: Illustrating effects of financial leverage nTwo firms with the same operating leverage, business risk, and probability distribution of EBIT. nOnly differ with respect to their use of debt (capital structure). Firm U Firm L No debt $10,000 of 12% debt $20,000 in assets $20,000 in assets 40% tax rate 40% tax rate 14-9 Firm U & Firm L (Tax =40%) U Economy Bad Avg. Good Prob. 0.25 0.50 0.25 EBIT $2,000 $3,000 $4,000 Interest 0 0 0 EBT $2,000 $3,000 $4,000 Taxes 800 1,200 1,600 NI $1,200 $1,800 $2,400 L Economy Bad Avg. Good Prob.* 0.25 0.50 0.25 EBIT* $2,000 $3,000 $4,000 Interest 1,200 1,200 1,200 EBT $800 $1,800$2,800 Taxes 320 720 1,120 NI $480 $1,080$1,680 *Same as for Firm U. 14-10 Ratio comparison between leveraged and unleveraged firms FIRM UBadAvgGood BEP 10.0% 15.0% 20.0% ROE 6.0% 9.0% 12.0% TIE FIRM LBadAvgGood BEP 10.0% 15.0% 20.0% ROE 4.8% 10.8% 16.8% TIE 1.67x 2.50x 3.33x 14-11 Risk and return for leveraged and unleveraged firms Expected Values: Firm UFirm L E(BEP)15.0%15.0% E(ROE) 9.0%10.8% E(TIE) 2.5x Risk Measures: Firm UFirm L ROE2.12%4.24% CVROE 0.24 0.39 14-12 The effect of leverage on profitability and debt coverage nFor leverage to raise expected ROE, must have BEP rd. nWhy? If rd BEP, then the interest expense will be higher than the operating income produced by debt-financed assets, so leverage will depress income. nAs debt increases, TIE decreases because EBIT is unaffected by debt, and interest expense increases (Int. Expense = rdD). 14-13 Conclusions nBasic earning power (BEP) is unaffected by financial leverage. nL has higher expected ROE because E(BEP) rd. nL has much wider ROE (and EPS) swings because of fixed interest charges. Its higher expected return is accompanied by higher risk. 14-14 Optimal Capital Structure nThe capital structure at which P0 is maximized. nTrades off higher E(ROE) and EPS against higher risk. The tax-related benefits of leverage are offset by the debts risk-related costs. 14-15 Costs of Financial Distress n1. Direct Costs nA. Costly litigation process nB. Lawyers fees, court costs 2. Indirect Costs A. Managers may engage in negative NPV projects to survive, e.g., selling valuable assets or profitable divisions. B. Customers, suppliers, employees 14-16 Agency Costs nProject A has a 50/50 chance of having $10M and $8M. nProject B has a 50/50 chance of having $20M and -$18M. nWhich project would you choose? nIf your debt is $12M? nVL = VU + Tax Benefit PV of Expected Financial Distress Costs PV of Agency Costs 14-17 Optimal Capital Structure Value of Stock 0 D1 D2 D/A Tax Benefit Actual No leverage 14-18 Business Risk nIf there were higher business risk, then the probability of financial distress would be greater at any debt level, and the optimal capital structure would be one that had less debt. nHowever, lower business risk would lead to an optimal capital structure with more debt. 14-19 Other factors to consider when establishing the firms target capital structure 1.Industry average debt ratio 2.TIE ratios under different scenarios 3.Lender/rating agency attitudes 4.Reserve borrowing capacity 5.Effects of financing on control 6.Asset structure 7.Expected tax rate 14-20 What are “signaling” effects in capital structure? nAssumptions: nManagers have better information about a firms long-run value than outside investors. nManagers act in the best interests of current stockholders. nWhat can managers be expected to do? nIssue stock if they think stock is overvalued. nIssue debt if they think stock is undervalued. nAs a result, investors view a