公司税和债务政策回顾

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1、Review Pre Mid-Term-Debt vs.Equity overview Last Lecture(Ch 17)reintroduced these topics Now-We will begin to add real world complexities.Topics Covered Debt and Value in a Tax Free Economy Corporate Taxes and Debt Policy Cost of Financial Distress Explaining Financial ChoicesM&M(Debt Policy Doesnt

2、Matter)Modigliani&Miller When 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)Assumptions By issuing 1

3、 security rather than 2,company diminishes investor choice.This does not reduce value if:Investors do not need choice,OR There are sufficient alternative securities Capital structure does not affect cash flows e.g.No taxes No bankruptcy costs No effect on management incentivesExample-River Cruises-A

4、ll Equity FinancedDataNumber of shares100,000Price per share$10Market Value of Shares$1 millionOutcome State of the EconomySlumpExpectedBoomOperating Income$75,000125,000175,000Earnings per share$.751.251.75Return on shares(%)7.5%12.517.5M&M(Debt Policy Doesnt Matter)Example cont.50%debtDataNumber o

5、f shares50,000Price per share$10Market Value of Shares$500,000Market value of debt$500,000Outcome State of the EconomySlumpExpectedBoomOperating Income$75,000125,000175,000Interest$50,00050,00050,000Equity earnings$25,00075,000125,000Earnings per share$.501.502.50Return on shares(%)5%1525M&M(Debt Po

6、licy Doesnt Matter)Example-River Cruises-All Equity Financed-Debt replicated by investorsOutcome State of the EconomySlumpExpectedBoomEarnings on two shares$1.502.503.50LESS:Interest 10%$1.001.001.00Net earnings on investment$.501.502.50Return on$10 investment(%)5%1525M&M(Debt Policy Doesnt Matter)F

7、inancial 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 TaxesExample-You own all the equity

8、 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 TaxesExample

9、-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

10、Equity1/2 DebtEBIT1,000Interest Pmt 0 Pretax Income1,000Taxes 40%400Net Cash Flow$600C.S.&Corporate Taxes All Equity1/2 DebtEBIT1,0001,000Interest Pmt 0 100 Pretax Income1,000 900Taxes 40%400 360Net Cash Flow$600$540Example-You own all the equity of Space Babies Diaper Co.The company has no debt.The

11、 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 TaxesC.S.&Corporate Taxes All Equity1/2 DebtEBIT1,0001,000Interest

12、 Pmt 0 100 Pretax Income1,000 900Taxes 40%400 360Net Cash Flow$600$540Total Cash Flow All Equity=600 (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 o

13、ption to exchange 1/2 of your equity position for 10%bonds with a face value of$1,000.Should you do this and why?Capital StructurePV of Tax Shield=(assume perpetuity)D x rD x Tc rD=D x TcCapital StructurePV of Tax Shield=(assume perpetuity)D x rD x Tc rD=D x TcExample:Tax benefit=1000 x(.10)x(.40)=$

14、40 Capital StructurePV of Tax Shield=(assume perpetuity)D x rD x Tc rD=D x TcExample:Tax benefit=1000 x(.10)x(.40)=$40 PV of 40 perpetuity=40/.10 =$400Capital StructurePV of Tax Shield=(assume perpetuity)D x rD x Tc rD=D x TcExample:Tax benefit=1000 x(.10)x(.40)=$40 PV of 40 perpetuity=40/.10 =$400P

15、V Tax Shield=D x Tc=1000 x.4 =$400Capital StructureFirm Value=Value of All Equity Firm+PV Tax ShieldCapital StructureFirm Value=Value of All Equity Firm+PV Tax ShieldExampleAll Equity Value=600/.10=6,000 Capital StructureFirm Value=Value of All Equity Firm+PV Tax ShieldExampleAll Equity Value=600/.1

16、0=6,000 PV Tax Shield =400Capital StructureFirm Value=Value of All Equity Firm+PV Tax ShieldExampleAll Equity Value=600/.10=6,000 PV Tax Shield =400Firm Value with 1/2 Debt=$6,400C.S.&Taxes(Personal&Corp)Relative Advantage Formula (Debt vs Equity)1-TP(1-TPE)(1-TC)C.S.&Taxes(Personal&Corp)Relative Ad

17、vantage 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&FinancingInteractionAdjusted Cost of Capital(alternative to WACC)Investment&FinancingInteractionMiles and EzzellDcDrrT

18、LrrWACC11Adjusted Present ValueAdjusted Discount RateWeighted Average Cost of CapitalInvestment&FinancingInteractionAfter 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

19、 tax rate.EDrVErVDWACCOld FormulaAfter Tax WACCEDrVErVDTcWACC)1(Tax Adjusted FormulaAfter Tax WACCExample-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 WA

20、CC?After Tax WACCExample-Sangria Corporation-continuedBalance Sheet(Book Value,millions)Assets10050Debt50EquityTotal assets100100Total liabilitiesAfter Tax WACCExample-Sangria Corporation-continuedBalance Sheet(Market Value,millions)Assets12550Debt75EquityTotal assets125125Total liabilitiesMARKET VA

21、LUESAfter Tax WACCExample-Sangria Corporation-continuedDebt ratio=(D/V)=50/125=.4 or 40%Equity ratio=(E/V)=75/125=.6 or 60%EDrVErVDTcWACC)1(After Tax WACCExample-Sangria Corporation-continuedEDrVErVDTcWACC)1(%84.101084.146.1257508.12550)35.1(WACCAfter Tax WACCExample-Sangria Corporation-continuedThe

22、 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 WACCExample-Sangria Corporation-continuedThe company would like to invest in a perpetual crushing mac

23、hine 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?Cash FlowsPretax cash flow2.085Tax 35%0.73After-tax cash flow$1.355 millionAfter Tax WACCExample-Sangria Corporation-continuedThe company would like to invest in a perp

24、etual 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?01084.355.15.1210grCCNPVREMEMBERCash Flow is BIAT=Before interest after taxesAfter Tax WACC Preferred stock and other forms of financing must be inclu

25、ded in the formula EPDrVErVPrVDTcWACC)1(After Tax WACCBalance Sheet(Market Value,millions)Assets12550Debt25Preferred Equity50Common EquityTotal assets125125Total liabilities%04.111104.146.1255010.1252508.12550)35.1(WACCExample-Sangria Corporation-continuedCalculate WACC given preferred stock is$25 m

26、il of total equity and yields 10%.Tricks of the Trade What should be included with debt?Long-term debt?Short-term debt?Cash(netted off?)Receivables?Deferred tax?Tricks of the Trade How are costs of financing determined?Return on equity can be derived from market data Cost of debt is set by the market given the specific rating of a firms debt Preferred stock often has a preset dividend rate