公司理财（英文版·第5版）课件 第14章　完美市场中的资本结构

CorporateFinanceFifthEditionChapter14CapitalStructureinaPerfectMarketCopyright©2020,2017,2014PearsonEducation,Inc.

AllRightsReservedChapterOutline14.1EquityVersusDebtFinancing14.2Modigliani–MillerI:Leverage,Arbitrage,andFirmValue14.3

Modigliani–MillerII:Leverage,Risk,andtheCostofCapital14.4CapitalStructureFallacies14.5

MM:BeyondthePropositionsLearningObjectives

(1of4)Definethetypesofsecuritiesusuallyusedbyfirmstoraisecapital;defineleverage.Describethecapitalstructurethatthefirmshouldchoose.Listthethreeconditionsthatmakecapitalmarketsperfect.LearningObjectives(2of4)DiscusstheimplicationsofMMPropositionI,andtherolesofhomemadeleverageandtheLawofOnePriceinthedevelopmentoftheproposition.CalculatethecostofcapitalforleveredequityaccordingtoMMPropositionII.Illustratetheeffectofachangeindebtonweightedaveragecostofcapitalinperfectcapitalmarkets.LearningObjectives(3of4)Calculatethemarketriskofafirm’sassetsusingitsunleveredbeta.Illustratetheeffectofincreasedleverageonthebetaofafirm’sequity.Computeafirm’snetdebt.Discusstheeffectofleverageonafirm’sexpectedearningspershare.LearningObjectives(4of4)Showtheeffectofdilutiononequityvalue.Explainwhyperfectcapitalmarketsneithercreatenordestroyvalue.14.1EquityVersusDebtFinancingCapitalStructureTherelativeproportionsofdebt,equity,andothersecuritiesthatafirmhasoutstandingFinancingaFirmwithEquity(1of6)Youareconsideringaninvestmentopportunity.Foraninitialinvestmentof$800thisyear,theprojectwillgeneratecashflowsofeither$1400or$900nextyear,dependingonwhethertheeconomyisstrongorweak,respectively.Bothscenariosareequallylikely.Table14.1TheProjectCashFlowsFinancingaFirmwithEquity(2of6)Theprojectcashflowsdependontheoveralleconomyandthuscontainmarketrisk.Asaresult,youdemanda10%riskpremiumoverthecurrentrisk−freeinterestrateof5%toinvestinthisproject.WhatistheN

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Vofthisinvestmentopportunity?FinancingaFirmwithEquity(3of6)Thecostofcapitalforthisprojectis15%.Theexpectedcashflowinoneyearis

TheN

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VoftheprojectisFinancingaFirmwithEquity(4of6)Ifyoufinancethisprojectusingonlyequity,howmuchwouldyoubewillingtopayfortheproject?Ifyoucanraise$1000bysellingequityinthefirm,afterpayingtheinvestmentcostof$800,youcankeeptheremaining$200,theN

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oftheprojectN

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V,asaprofit.FinancingaFirmwithEquity(5of6)UnleveredEquityEquityinafirmwithnodebtBecausethereisnodebt,thecashflowsoftheunleveredequityareequaltothoseoftheproject.Table14.2CashFlowsandReturnsforUnleveredEquityFinancingaFirmwithEquity(6of6)Shareholder’sreturnsareeither40%or10%

Becausethecostofcapitaloftheprojectis15%,shareholdersareearninganappropriatereturnfortherisktheyaretaking.FinancingaFirmwithDebtandEquity(1of6)Supposeyoudecidetoborrow$500initially,inadditiontosellingequityBecausetheproject’scashflowwillalwaysbeenoughtorepaythedebt,thedebtisriskfree,andyoucanborrowattherisk−freeinterestrateof5%.Youwillowethedebtholders

inoneyear.LeveredEquityEquityinafirmthatalsohasdebtoutstandingFinancingaFirmwithDebtandEquity(2of6)Giventhefirm’s$525debtobligation,yourshareholderswillreceiveonlyiftheeconomyisstrongandiftheeconomyisweak.Table14.3ValuesandCashFlowsforDebtandEquityoftheLeveredFirmFinancingaFirmwithDebtandEquity(3of6)WhatpriceE

shouldtheleveredequitysellfor?Whichisthebestcapitalstructurechoicefortheentrepreneur?FinancingaFirmwithDebtandEquity(4of6)ModiglianiandMillerarguedthatwithperfectcapitalmarkets,thetotalvalueofafirmshouldnotdependonitscapitalstructure.Theyreasonedthatthefirm’stotalcashflowsstillequalthecashflowsoftheprojectand,therefore,havethesamepresentvalue.FinancingaFirmwithDebtandEquity(5of6)Becausethecashflowsofthedebtandequitysumtothecashflowsoftheproject,bytheLawofOnePricethecombinedvaluesofdebtandequitymustbe$1000.Therefore,ifthevalueofthedebtis$500,thevalueoftheleveredequitymustbe$500.

FinancingaFirmwithDebtandEquity(6of6)Becausethecashflowsofleveredequityaresmallerthanthoseofunleveredequity,leveredequitywillsellforalowerprice($500versus$1000).However,youarenotworseoff.Youwillstillraiseatotalof$1000byissuingbothdebtandleveredequity.Consequently,youwouldbeindifferentbetweenthesetwochoicesforthefirm’scapitalstructure.TheEffectofLeverageonRiskandReturn(1of6)Leverageincreasestheriskoftheequityofafirm.Therefore,itisinappropriatetodiscountthecashflowsofleveredequityatthesamediscountrateof15%thatyouusedforunleveredequity.Investorsinleveredequitywillrequireahigherexpectedreturntocompensatefortheincreasedrisk.Table14.4ReturnstoEquitywithandwithoutLeverageTheEffectofLeverageonRiskandReturn(2of6)Thereturnstoequityholdersareverydifferentwithandwithoutleverage.Unleveredequityhasareturnofeither40%or10%,foranexpectedreturnof15%.Leveredequityhashigherrisk,withareturnofeither75%orTocompensateforthisrisk,leveredequityholdersreceiveahigherexpectedreturnof25%.TheEffectofLeverageonRiskandReturn(3of6)Therelationshipbetweenriskandreturncanbeevaluatedmoreformallybycomputingthesensitivityofeachsecurity’sreturntothesystematicriskoftheeconomy.Table14.5SystematicRiskandRiskPremiumsforDebt,UnleveredEquity,andLeveredEquityBlankReturnSensitivity(SystematicRisk)RiskpremiumBlankDelta

R=R(strong)minusR(weak)EleftbracketRrightbracketminusrsubfDebt5%minus5%=0%5%minus5%=0%Unleveredequity75%minusleftparenthesisnegative25%rightparenthesis=100%15%minus5%=10%Leveredequity40%minusleftparenthesisminus10%rightparenthesis=50%25%minus5%=20%TheEffectofLeverageonRiskandReturn(4of6)Becausethedebt’sreturnbearsnosystematicrisk,itsriskpremiumiszero.Inthisparticularcase,theleveredequityhastwicethesystematicriskoftheunleveredequityand,asaresult,hastwicetheriskpremium.TheEffectofLeverageonRiskandReturn(5of6)Insummary,Inthecaseofperfectcapitalmarkets,ifthefirmis100%equityfinanced,theequityholderswillrequirea15%expectedreturn.Ifthefirmisfinanced50%withdebtand50%withequity,thedebtholderswillreceiveareturnof5%,whiletheleveredequityholderswillrequireanexpectedreturnof25%(becauseoftheirincreasedrisk).TheEffectofLeverageonRiskandReturn(6of6)Insummary,Leverageincreasestheriskofequityevenwhenthereisnoriskthatthefirmwilldefault.Thus,whiledebtmaybecheaper,itsuseraisesthecostofcapitalforequity.Consideringbothsourcesofcapitaltogether,thefirm’saveragecostofcapitalwithleverageisthesameasfortheunleveredfirm.TextbookExample14.1(1of2)LeverageandtheEquityCostofCapitalProblemSupposetheentrepreneurborrowsonly$200whenfinancingtheproject.AccordingtoModiglianiandmiller,whatshouldthevalueoftheequitybe?Whatistheexpectedreturn?TextbookExample14.1

(2of2)Becausethevalueofthefirm’stotalcashflowsisstill$1000,ifthefirmborrows$200,itsequitywillbeworth$800.thefirmwilloweinoneyear.Thus,iftheeconomyisstrong,equityholderswillreceiveforareturnofreturnofTheequityhasanexpectedreturnofNotethattheequityhasareturnsensitivityofwhichisofthesensitivityofunleveredequity.Itsriskpremiumiswhichisalso125%oftheriskpremiumoftheunleveredequity,soitisappropriatecompensationfortherisk.AlternativeExample14.1(1of3)ProblemSupposetheentrepreneurborrows$700whenfinancingtheproject.AccordingtoModiglianiandMiller,whatshouldthevalueoftheequitybe?Whatistheexpectedreturn?AlternativeExample14.1(2of3)SolutionBecausethevalueofthefirm’stotalcashflowsisstill$1000,ifthefirmborrows$700,itsequitywillbeworth$300.Thefirmwilloweinoneyear.Thus,iftheeconomyisstrong,equityholderswillreceiveforareturnofIftheeconomyisweak,equityholderswillreceiveforareturnofTheequityhasanexpectedreturnofAlternativeExample14.1(3of3)SolutionNotethattheequityhasareturnsensitivityofwhichisofthesensitivityofunleveredequity.Itsriskpremiumiswhichisapproximately333.34%oftheriskpremiumoftheunleveredequity,soitisappropriatecompensationfortherisk.14.2Modigliani−MillerI:Leverage,Arbitrage,andFirmValue(1of3)TheLawofOnePriceimpliesthatleveragewillnotaffectthetotalvalueofthefirm.Instead,itmerelychangestheallocationofcashflowsbetweendebtandequity,withoutalteringthetotalcashflowsofthefirm.14.2Modigliani−MillerI:Leverage,Arbitrage,andFirmValue(2of3)ModiglianiandMiller(M

M

)showedthatthisresultholdsmoregenerallyunderasetofconditionsreferredtoasperfectcapitalmarkets:Investorsandfirmscantradethesamesetofsecuritiesatcompetitivemarketpricesequaltothepresentvalueoftheirfuturecashflows.Therearenotaxes,transactioncosts,orissuancecostsassociatedwithsecuritytrading.Afirm’sfinancingdecisionsdonotchangethecashflowsgeneratedbyitsinvestments,nordotheyrevealnewinformationaboutthem.14.2Modigliani−MillerI:Leverage,Arbitrage,andFirmValue(3of3)M

MPropositionIInaperfectcapitalmarket,thetotalvalueofafirmisequaltothemarketvalueofthetotalcashflowsgeneratedbyitsassetsandisnotaffectedbyitschoiceofcapitalstructure.MMandtheLawofOnePriceM

Mestablishedtheirresultwiththefollowingargument:Intheabsenceoftaxesorothertransactioncosts,thetotalcashflowpaidouttoallofafirm’ssecurityholdersisequaltothetotalcashflowgeneratedbythefirm’sassets.Therefore,bytheLawofOnePrice,thefirm’ssecuritiesanditsassetsmusthavethesametotalmarketvalue.HomemadeLeverage(1of5)HomemadeLeverageWheninvestorsuseleverageintheirownportfoliostoadjusttheleveragechoicemadebythefirmM

Mdemonstratedthatifinvestorswouldpreferanalternativecapitalstructuretotheonethefirmhaschosen,investorscanborroworlendontheirownandachievethesameresult.HomemadeLeverage(2of5)Assumeyouusenoleverageandcreateanall−equityfirmAninvestorwhowouldprefertoholdleveredequitycandosobyusingleverageinhisownportfolio.Table14.6ReplicatingLeveredEquityUsingHomemadeLeverageHomemadeLeverage(3of5)Ifthecashflowsoftheunleveredequityserveascollateralforthemarginloan(attherisk−freerateof5%),thenbyusinghomemadeleverage,theinvestorhasreplicatedthepayoffstotheleveredequity,asillustratedinthepreviousslide,foracostof$500.BytheLawofOnePrice,thevalueofleveredequitymustalsobe$500.HomemadeLeverage(4of5)Nowassumeyouusedebt,buttheinvestorwouldprefertoholdunleveredequity.Theinvestorcanreplicatethepayoffsofunleveredequitybybuyingboththedebtandtheequityofthefirm.Combiningthecashflowsofthetwosecuritiesproducescashflowsidenticaltounleveredequity,foratotalcostof$1000.Table14.7ReplicatingUnleveredEquitybyHoldingDebtandEquityHomemadeLeverage(5of5)Ineachcase,yourchoiceofcapitalstructuredoesnotaffecttheopportunitiesavailabletoinvestors.Investorscanaltertheleveragechoiceofthefirmtosuittheirpersonaltasteseitherbyaddingmoreleverageorbyreducingleverage.Withperfectcapitalmarkets,differentchoicesofcapitalstructureoffernobenefittoinvestorsanddoesnotaffectthevalueofthefirm.TextbookExample14.2(1of3)HomemadeLeverageandArbitrageProblemSupposetherearetwofirms,eachwithdate1cashflowsof$1400or$900(asshowinTable14.1).Thefirmsareidenticalexceptfortheircapitalstructure.Onefirmisunlevered,anditsequityhasamarketvalueof$510.DoesMMpropositionIhold?Whatarbitrageopportunityisavailableusinghomemadeleverage?TextbookExample14.2(2of3)SolutionMMpropositionIstatesthatthetotalvalueofeachfirmshouldequalthevalueofitsassets.Becausethesefirmsholdidenticalassets,theirtotalvaluesshouldbethesame.However,theproblemassumestheunleveredfirmhasatotalmarketvalueof$990,wherestheleveredfirmhasatotalmarketvalueoftherefore,thesepricesviolateM

MpropositionI.Becausethesetwoidenticalfirmsaretradingfordifferenttotalprices,theLawofOnepriceisviolatedandanarbitrageopportunityexists.Toexploitit,wecanborrow$500andbuytheequityoftheunleveredfirmfor$990,re-creatingtheequityoftheleveredfirmbyusinghomemadeleverageforacostofonlywecanthenselltheequityoftheleveredfirmfor$510andenjoyanarbitrageprofitof$20.TextbookExample14.2(3of3)blankDate0Date1:CashFlowsblankBlankCashFlowStrongEconomyWeakEconomyBorrow$500minus$525minus$525Buyunleveredequityminus$990$1400$900Sellleveredequity$510minus$875minus$375Totalcashflow$20$0$0Notethattheactionofarbitrageursbuyingtheunleveredfirmandsellingtheleveredfirmwillcausepriceoftheunleveredfirm’sstocktoriseandthepriceoftheleveredfirm’sstocktofalluntilthefirms’valuesareequalandM

MpropositionIholds.AlternativeExample14.2(1of3)ProblemSupposetherearetwofirms,eachwithdate1cashflowsof$1400or$900(asshowninTable14.1).Thefirmsareidenticalexceptfortheircapitalstructure.Onefirmisunlevered,anditsequityhasamarketvalueof$1010.Theotherfirmhasborrowed$500,anditsequityhasamarketvalueof$500.DoesM

MPropositionIhold?Whatarbitrageopportunityisavailableusinghomemadeleverage?AlternativeExample14.2(2of3)SolutionM

MPropositionIstatesthatthetotalvalueofeachfirmshouldequalthevalueofitsassets.Becausethesefirmsholdidenticalassets,theirtotalvaluesshouldbethesame.However,theproblemassumestheunleveredfirmhasatotalmarketvalueof$1010,whereastheleveredfirmhasatotalmarketvalueofTherefore,thesepricesviolateM

MPropositionI.AlternativeExample14.2(3of3)BlankDate0Date1:CashFlowsBlankBlankCashFlowStrongEconomyWeakEconomyBuyleveredequityminus$500$875$375Buylevereddebtminus$500$525$525Sellunleveredequity$,010$1,400minus$900Totalcashflow$10$0$0Notethattheactionsofarbitrageursbuyingtheleveredfirm’sequityanddebtandsellingtheunleveredfirm’sequitywillcausethepriceoftheleveredfirm’sequitytoriseandthepriceoftheunleveredfirm’sequitytofalluntilthefirms’valuesareequal.TheMarketValueBalanceSheet(1of2)MarketValueBalanceSheetAbalancesheetwhere:Allassetsandliabilitiesofthefirmareincluded(evenintangibleassetssuchasreputation,brandname,orhumancapitalthataremissingfromastandardaccountingbalancesheet).Allvaluesarecurrentmarketvaluesratherthanhistoricalcosts.Thetotalvalueofallsecuritiesissuedbythefirmmustequalthetotalvalueofthefirm’sassets.Table14.8TheMarketValueBalanceSheetoftheFirmAssetsLiabilitiesCollectionofAssetsandInvestmentsUndertakenbytheFirm:TangibleAssetsCashPlant,property,andequipmentInventoryandotherworkingcapital(andsoon)IntangibleAssetsIntellectualpropertyReputationHumancapital(andsoon)CollectionofsecuritiesIssued

bytheFirm:Debt

Short-termdebtLong-termdebtConvertibledebtEquityCommonstockPreferredstockWarrants(options)TotalmarketvalueofFirmAssetsTotalMarketvalueofFirmSecuritiesTheMarketValueBalanceSheet(2of2)Usingthemarketvaluebalancesheet,thevalueofequityiscomputedasfollows:TextbookExample14.3(1of2)ValuingEquityWhenThereAreMultipleSecuritiesProblemSupposeourentrepreneurdecidestosellthefirmbysplittingitintotheresecurities:$500ofdebt,andathirdsecuritycalledawarrantthatpays$210whenthefirm’scashflowarehighandnothingwhenthecashflowsarelow.Supposethatthisthirdsecurityisfairlypricedat$60.Whatwillthevalueoftheequitybeinaperfectcapitalmarket?TextbookExample14.3(2of2)SolutionAccordingtoM

MPropositionI,thetotalvalueofallsecuritiesissuedshouldequalthevalueoftheassetsofthefirm,whichis$1000.Becausethedebtisworth$500andthenewsecurityisworth$60,thevalueoftheequitymustbe$440.(Youcancheckthisresultbyverifyingthatatthisprice,equityhasariskpremiumcommensuratewithitsincomparisonwiththesecuritiesintable14.5.)AlternativeExample14.3(1of2)ProblemAssumethatthesocialmediaappyoudevelopedhasgoneviralandyoudecidedtosellthecompany,whichhas$60millioninassets.Youplanonsplittingthefirmintoequity,debt,andwarrants,andyouexpecttosell$10millionindebtand$15millioninwarrants.Whatwillthevalueoftheequitybeinaperfectcapitalmarket?AlternativeExample14.3(2of2)SolutionAccordingtoM

MPropositionI,thetotalvalueofallsecuritiesissuedshouldequalthevalueoftheassets,or$60million.Giventhatthedebtisworth$10millionandthewarrantsareworth$15million,thevalueoftheequitymustbe$35million.Application:ALeveragedRecapitalization(1of7)LeveragedRecapitalizationWhenafirmusesborrowedfundstopayalargespecialdividendorrepurchaseasignificantamountofoutstandingsharesApplication:ALeveragedRecapitalization(2of7)Example:HarrisonIndustriesiscurrentlyanall−equityfirmoperatinginaperfectcapitalmarket,with50millionsharesoutstandingthataretradingfor$4pershare.Harrisonplanstoincreaseitsleveragebyborrowing$80millionandusingthefundstorepurchase20millionofitsoutstandingshares.Application:ALeveragedRecapitalization(3of7)ExampleThistransactioncanbeviewedintwostages.First,Harrisonsellsdebttoraise$80millionincash.Second,Harrisonusesthecashtorepurchaseshares.Table14.9MarketValueBalanceSheetafterEachStageofHarrison’sLeveragedRecapitalization($millions)Application:ALeveragedRecapitalization(4of7)ExampleInitially,Harrisonisanall−equityfirmandthemarketvalueofHarrison’sequityis$200millionandequalsthemarketvalueofitsexistingassets.Application:ALeveragedRecapitalization(5of7)ExampleAfterborrowing,Harrison’sliabilitiesgrowby$80million,whichisalsoequaltotheamountofcashthefirmhasraised.Becausebothassetsandliabilitiesincreasebythesameamount,themarketvalueoftheequityremainsunchanged.Application:ALeveragedRecapitalization(6of7)ExampleToconductthesharerepurchase,Harrisonspendsthe$80millioninborrowedcashtorepurchase20millionshares.Becausethefirm’sassetsdecreaseby$80millionanditsdebtremainsunchanged,themarketvalueoftheequitymustalsofallby$80million,from$200millionto$120million,forassetsandliabilitiestoremainbalanced.Application:ALeveragedRecapitalization(7of7)ExampleThesharepriceisunchangedWith30millionsharesremaining,thesharesareworth$4pershare,justasbefore.14.3Modigliani−MillerII:Leverage,Risk,andtheCostofCapital(1of9)LeverageandtheEquityCostofCapitalM

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’sfirstpropositioncanbeusedtoderiveanexplicitrelationshipbetweenleverageandtheequitycostofcapital.14.3Modigliani−MillerII:Leverage,Risk,andtheCostofCapital(2of9)LeverageandtheEquityCostofCapitalEMarketvalueofequityinaleveredfirmDMarketvalueofdebtinaleveredfirmUMarketvalueofequityinanunleveredfirmAMarketvalueofthefirm’sassets14.3Modigliani−MillerII:Leverage,Risk,andtheCostofCapital(3of9)LeverageandtheEquityCostofCapitalM

MPropositionIstatesthatThetotalmarketvalueofthefirm’ssecuritiesisequaltothemarketvalueofitsassets,whetherthefirmisunleveredorlevered.14.3Modigliani−MillerII:Leverage,Risk,andtheCostofCapital(4of9)LeverageandtheEquityCostofCapitalThecashflowsfromholdingunleveredequitycanbereplicatedusinghomemadeleveragebyholdingaportfolioofthefirm’sequityanddebt.14.3Modigliani−MillerII:Leverage,Risk,andtheCostofCapital(5of9)LeverageandtheEquityCostofCapitalThereturnonunleveredequityisrelatedtothereturnsofleveredequityanddebt14.3Modigliani−MillerII:Leverage,Risk,andtheCostofCapital(6of9)LeverageandtheEquityCostofCapitalSolvingforTheleveredequityreturnequalstheunleveredreturn,plusapremiumduetoleverage.Theamountofthepremiumdependsontheamountofleverage,measuredbythefirm’smarketvaluedebt−equityratio,14.3Modigliani−MillerII:Leverage,Risk,andtheCostofCapital(7of9)LeverageandtheEquityCostofCapitalM

MPropositionII:Thecostofcapitalofleveredequityisequaltothecostofcapitalofunleveredequityplusapremiumthatisproportionaltothemarketvaluedebt−equityratioCostofCapitalofLeveredEquity14.3Modigliani−MillerII:Leverage,Risk,andtheCostofCapital(8of9)LeverageandtheEquityCostofCapitalRecallfromabove:Ifthefirmisall−equityfinanced,theexpectedreturnonunleveredequityis15%.Ifthefirmisfinancedwith$500ofdebt,theexpectedreturnofthedebtis5%.14.3Modigliani−MillerII:Leverage,Risk,andtheCostofCapital(9of9)LeverageandtheEquityCostofCapitalTherefore,accordingtoM

MPropositionII,theexpectedreturnonequityfortheleveredfirmisTextbookExample14.4(1of2)ComputingtheEquityCotofCapitalProblemSupposetheentrepreneurofsection14.1borrowonly$200whenfinancingtheproject.AccordingtoM

Mproposition11,whatwillbethefirm’sequitycostofcapital?TextbookExample14.4(2of2)SolutionBecausethefirm’sassetshaveamarketvalueof$1000,byM

MPropositionItheequitywillhaveamarketvalueof$800.ThenusingEquation14.5ThisresultmatchestheexpectedreturncalculateinExample14.1.AlternativeExample14.4(1of2)ProblemSupposetheentrepreneurinAlternativeExample14.1borrowsonly$700whenfinancingtheproject.Recallthattheexpectedreturnonunleveredequityis15%andtherisk−freerateis5%.AccordingtoM

MPropositionII,whatwillbethefirm’sequitycostofcapital?AlternativeExample14.4(2of2)SolutionBecausethefirm’sassetshaveamarketvalueof$1000,byM

MPropositionItheequitywillhaveamarketvalueof$300.Then,usingEquation14.5,ThisresultmatchestheexpectedreturncalculatedinExample14.1.CapitalBudgetingandtheWeightedAverageCostofCapital(1of4)Ifafirmisunlevered,allofthefreecashflowsgeneratedbyitsassetsarepaidouttoitsequityholdersThemarketvalue,risk,andcostofcapitalforthefirm’sassetsanditsequitycoincideandthereforeCapitalBudgetingandtheWeightedAverageCostofCapital(2of4)Ifafirmislevered,projectrAisequaltothefirm’sweightedaveragecostofcapital.UnleveredCostofCapital(PretaxW

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C)CapitalBudgetingandtheWeightedAverageCostofCapital(3of4)Withperfectcapitalmarkets,afirm’sW

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Cisindependentofitscapitalstructureandisequaltoitsequitycostofcapitalifitisunlevered,whichmatchesthecostofcapitalofitsassets.Debt−to−ValueRatioThefractionofafirm’senterprisevaluethatcorrespondstodebtFigure14.1WACCandLeveragewithPerfectCapitalMarkets(a)Equity,debt,andweightedaveragecostsofcapitalfordifferentamountsofleverage.TherateofincreaseofrDandrE,andthustheshapeofthecurves,dependsonthecharacteristicsofthefirm’scashflows.(b)CalculatingtheW

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Cforalternativecapitalstructures.DatainthistablecorrespondtotheexampleinSection14.1.CapitalBudgetingandtheWeightedAverageCostofCapital(4of4)Withnodebt,theW

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Cisequaltotheunleveredequitycostofcapital.Asthefirmborrowsatthelowcostofcapitalfordebt,itsequitycostofcapitalrises.Theneteffectisthatthefirm’sW

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Cisunchanged.TextbookExample14.5(1of3)ReducingLeverageandtheCostofCapitalProblemNRGEnergy,Inc.(N

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G)isanenergycompanywithamarketdebt-equityratioof2.Supposeitscurrentdebtcostofcapitalis6%,anditsequitycostofcapitalis12%.SupposealsothatifN

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Gissuesequityandusestheproceedstorepayitsjuniordebtandreduceitsdebt-equityratioto1,itwillloweritsdebtcostofcapitalto5.5%.Withperfectcapitalmarkets,whateffectwillthistransactionhaveonN

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’sequitycostofcapitalandW

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C?WhatwouldhappenifN

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Gissuesevenmoreequityandpaysoffitsdebtcompletely?HowwouldthesealternativecapitalstructuresaffectN

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’senterprisevalue?TextbookExample14.5(2of3)SolutionWecancalculateN

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’sinitialW

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CandunleveredcostofcapitalusingEqs.14.6and14.7:GivenN

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’sunleveredcostofcapitalof8%,wecanuseEq.14.5tocalculateN

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’sequitycostofcapitalafterthereductioninleverage:TextbookExample14.5(3of3)ThereductioninleveragewillcauseN

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G’sequitycostofcapitaltofallto10.5%.Notethough,thatwithperfectcapitalmarkets,N

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Cremainunchangedatandthereisnonetgainfromthistransaction.IfN

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Gpaysoffitsdebtcompletely,itwillbeunlevered.Thus,itsequitycostofcapitalwillequalitsW

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Candunleveredcostofcapitalof8%.Ineitherscenario,N