corporate financial theory 7 公司财务理论

Review,Pre Mid-Term - Debt vs. Equity overviewLast Lecture (Ch 17) reintroduced these topicsNow - We will begin to add real world complexities.,Topics Covered,Debt and Value in a Tax Free EconomyCorporate Taxes and Debt PolicyCost of Financial DistressExplaining Financial Choices,M&M (Debt Policy Doesnt Matter),Modigliani & MillerWhen there are no taxes and capital markets function well, it makes no difference whether the firm borrows or individual shareholders borrow. Therefore, the market value of a company does not depend on its capital structure.,M&M (Debt Policy Doesnt Matter),AssumptionsBy issuing 1 security rather than 2, company diminishes investor choice. This does not reduce value if: Investors do not need choice, OR There are sufficient alternative securitiesCapital structure does not affect cash flows e.g.No taxesNo bankruptcy costsNo effect on management incentives,Example - River Cruises - All Equity Financed,M&M (Debt Policy Doesnt Matter),Example cont.50% debt,M&M (Debt Policy Doesnt Matter),Example - River Cruises - All Equity Financed- Debt replicated by investors,M&M (Debt Policy Doesnt Matter),Financial Risk - Risk to shareholders resulting from the use of debt.Financial Leverage - Increase in the variability of shareholder returns that comes from the use of debt.Interest Tax Shield- Tax savings resulting from deductibility of interest payments.,C.S. & Corporate Taxes,Example - You own all the equity of Space Babies Diaper Co. The company has no debt. The companys annual cash flow is $1,000, before interest and taxes. The corporate tax rate is 40%. You have the option to exchange 1/2 of your equity position for 10% bonds with a face value of $1,000. Should you do this and why?,C.S. & Corporate Taxes,Example - You own all the equity of Space Babies Diaper Co. The company has no debt. The companys annual cash flow is $1,000, before interest and taxes. The corporate tax rate is 40%. You have the option to exchange 1/2 of your equity position for 10% bonds with a face value of $1,000. Should you do this and why?,All Equity1/2 DebtEBIT1,000Interest Pmt 0 Pretax Income1,000Taxes 40% 400Net Cash Flow$600,C.S. & Corporate Taxes,All Equity1/2 DebtEBIT1,0001,000Interest Pmt 0 100 Pretax Income1,000 900Taxes 40% 400 360Net Cash Flow$600$540,Example - You own all the equity of Space Babies Diaper Co. The company has no debt. The companys annual cash flow is $1,000, before interest and taxes. The corporate tax rate is 40%. You have the option to exchange 1/2 of your equity position for 10% bonds with a face value of $1,000. Should you do this and why?,C.S. & Corporate Taxes,C.S. & Corporate Taxes,All Equity1/2 DebtEBIT1,0001,000Interest Pmt 0 100 Pretax Income1,000 900Taxes 40% 400 360Net Cash Flow$600$540,Total Cash Flow All Equity = 600*1/2 Debt = 640 (540 + 100),Example - You own all the equity of Space Babies Diaper Co. The company has no debt. The companys annual cash flow is $1,000, before interest and taxes. The corporate tax rate is 40%. You have the option to exchange 1/2 of your equity position for 10% bonds with a face value of $1,000. Should you do this and why?,Capital Structure,PV of Tax Shield = (assume perpetuity),D x rD x Tc rD,= D x Tc,Capital Structure,PV of Tax Shield = (assume perpetuity),D x rD x Tc rD,= D x Tc,Example:Tax benefit = 1000 x (.10) x (.40) = $40,Capital Structure,PV of Tax Shield = (assume perpetuity),D x rD x Tc rD,= D x Tc,Example:Tax benefit = 1000 x (.10) x (.40) = $40 PV of 40 perpetuity = 40 / .10 = $400,Capital Structure,PV of Tax Shield = (assume perpetuity),D x rD x Tc rD,= D x Tc,Example:Tax benefit = 1000 x (.10) x (.40) = $40 PV of 40 perpetuity = 40 / .10 = $400PV Tax Shield = D x Tc = 1000 x .4 = $400,Capital Structure,Firm Value = Value of All Equity Firm + PV Tax Shield,Capital Structure,Firm Value = Value of All Equity Firm + PV Tax Shield,ExampleAll Equity Value = 600 / .10 = 6,000,Capital Structure,Firm Value = Value of All Equity Firm + PV Tax Shield,ExampleAll Equity Value = 600 / .10 = 6,000 PV Tax Shield = 400,Capital Structure,Firm Value = Value of All Equity Firm + PV Tax Shield,ExampleAll Equity Value = 600 / .10 = 6,000 PV Tax Shield = 400Firm Value with 1/2 Debt = $6,400,C.S. & Taxes (Personal & Corp),Relative Advantage Formula ( Debt vs Equity ),1-TP,(1-TPE) (1-TC),C.S. & Taxes (Personal & Corp),Relative Advantage Formula ( Debt vs Equity ),1-TP,(1-TPE) (1-TC),RAF 1 DebtRAF ADR = r (1 - Tc L ) L = Debt / Valuer = Cost of equity all equityTc = Corp Tax Ratealternative to WACC (almost same results),Investment & FinancingInteraction,Adjusted Cost of Capital(alternative to WACC),Investment & FinancingInteraction,Miles and Ezzell,Adjusted Present ValueAdjusted Discount RateWeighted Average Cost of Capital,Investment & FinancingInteraction,After Tax WACC,The tax benefit from interest expense deductibility must be included in the cost of funds. This tax benefit reduces the effective cost of debt by a factor of the marginal tax rate.,Old Formula,After Tax WACC,Tax Adjusted Formula,After Tax WACC,Example - Sangria CorporationThe firm has a marginal tax rate of 35%. The cost of equity is 14.6% and the pretax cost of debt is 8%. Given the book and market value balance sheets, what is the tax adjusted WACC?,After Tax WACC,Example - Sangria Corporation - continued,After Tax WACC,Example - Sangria Corporation - continued,MARKET VALUES,After Tax WACC,Example - Sangria Corporation - continued,Debt ratio = (D/V) = 50/125 = .4 or 40%Equity ratio = (E/V) = 75/125 = .6 or 60%,After Tax WACC,Example - Sangria Corporation - continued,After Tax WACC,Example - Sangria Corporation - continuedThe company would like to invest in a perpetual crushing machine with cash flows of $2.085 million per year pre-tax. Given an initial investment of $12.5 million, what is the value of the machine?,After Tax WACC,Example - Sangria Corporation - continuedThe company would like to invest in a perpetual crushing machine with cash flows of $2.085 million per year pre-tax. Given an initial investment of $12.5 million, what is the value of the machine?,After Tax WACC,Example - Sangria Corporation - continuedThe company would like to invest in a perpetual crushing machine with cash flows of $2.085 million per year pre-tax. Given an initial invest