DebtPolicyDoesn’tMatter(英文版)

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1、 1Review Pre Mid-Term-Debt vs.Equity overview Last Lecture(Ch 17)reintroduced these topics Now-We will begin to add real world complexities.2Topics Covered Debt and Value in a Tax Free Economy Corporate Taxes and Debt Policy Cost of Financial Distress Explaining Financial Choices 3M&M(Debt Policy Do

2、esnt 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.4M&M(Debt Policy Doesnt Matter)Assumptions By iss

3、uing 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 securities Capital structure does not affect cash flows e.g.No taxes No bankruptcy costs No effect on management incentives 5Example-River C

4、ruises-All 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)6Example cont.50%debtDat

5、aNumber of 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&

6、M(Debt Policy Doesnt Matter)7Example-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 Doesn

7、t Matter)8Financial 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 9Example-You own a

8、ll 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

9、 Taxes 10Example-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 t

10、his and why?All Equity1/2 DebtEBIT1,000Interest Pmt 0 Pretax Income1,000Taxes 40%400Net Cash Flow$600C.S.&Corporate Taxes 11 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 comp

11、any 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 12C.S.&Corporate Taxes All Equity1/2 Debt

12、EBIT1,0001,000Interest 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

13、 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?13Capital StructurePV of Tax Shield=(assume perpetuity)D x rD x Tc rD=D x Tc 14Capital StructurePV of Tax Shield=(assume perpetuity)D x rD x Tc rD=D x TcExample:Tax

14、benefit=1000 x(.10)x(.40)=$40 15Capital 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 =$400 16Capital StructurePV of Tax Shield=(assume perpetuity)D x rD x Tc rD=D x TcExample:Tax benefit=1000 x(.10)x(.40)=$40 P

15、V of 40 perpetuity=40/.10 =$400PV Tax Shield=D x Tc=1000 x.4 =$400 17Capital StructureFirm Value=Value of All Equity Firm+PV Tax Shield 18Capital StructureFirm Value=Value of All Equity Firm+PV Tax ShieldExampleAll Equity Value=600/.10=6,000 19Capital StructureFirm Value=Value of All Equity Firm+PV

16、Tax ShieldExampleAll Equity Value=600/.10=6,000 PV Tax Shield =400 20Capital 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=$6,400 21C.S.&Taxes(Personal&Corp)Relative Advantage Formula (Debt vs Equity)1-TP(1-

17、TPE)(1-TC)22C.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 45Adjusted Cost of Capital(alternative to WACC)In

18、vestment&FinancingInteractionMiles and EzzellDcDrrTLrrWACC11 46Adjusted Present ValueAdjusted Discount RateWeighted Average Cost of CapitalInvestment&FinancingInteraction 47After Tax WACC The tax benefit from interest expense deductibility must be included in the cost of funds.This tax benefit reduc

19、es the effective cost of debt by a factor of the marginal tax rate.EDrVErVDWACCOld Formula 48After Tax WACCEDrVErVDTcWACC)1(Tax Adjusted Formula 49After 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 b

20、ook and market value balance sheets,what is the tax adjusted WACC?50After Tax WACCExample-Sangria Corporation-continuedBalance Sheet(Book Value,millions)Assets10050Debt50EquityTotal assets100100Total liabilities 51After Tax WACCExample-Sangria Corporation-continuedBalance Sheet(Market Value,millions

21、)Assets12550Debt75EquityTotal assets125125Total liabilitiesMARKET VALUES 52After Tax WACCExample-Sangria Corporation-continuedDebt ratio=(D/V)=50/125=.4 or 40%Equity ratio=(E/V)=75/125=.6 or 60%EDrVErVDTcWACC)1(53After Tax WACCExample-Sangria Corporation-continuedEDrVErVDTcWACC)1(%84.101084.146.1257

22、508.12550)35.1(WACC 54After Tax WACCExample-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?55After Tax WACCExample-Sangria Cor

23、poration-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?Cash FlowsPretax cash flow2.085Tax 35%0.73After-tax cash flow$1.355 million 56After Tax WA

24、CCExample-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?01084.355.15.1210grCCNPVREMEMBERCash Flow is BIAT=Before interest aft

25、er taxes 57After Tax WACC Preferred stock and other forms of financing must be included in the formula EPDrVErVPrVDTcWACC)1(58After Tax WACCBalance Sheet(Market Value,millions)Assets12550Debt25Preferred Equity50Common EquityTotal assets125125Total liabilities%04.111104.146.1255010.1252508.12550)35.1

26、(WACCExample-Sangria Corporation-continuedCalculate WACC given preferred stock is$25 mil of total equity and yields 10%.59Tricks of the Trade What should be included with debt?Long-term debt?Short-term debt?Cash(netted off?)Receivables?Deferred tax?60Tricks 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