DebtPolicyDoesn’tMatter(英文版)44331.pptx

1ReviewPre Mid-Term-Debt vs.Equity overviewLast Lecture(Ch 17)reintroduced these topicsNow-We will begin to add real world complexities.2Topics CoveredDebt and Value in a Tax Free EconomyCorporate Taxes and Debt PolicyCost of Financial DistressExplaining Financial Choices 3M&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.4M&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 5Example-River Cruises-All Equity FinancedM&M(Debt Policy Doesnt Matter)6Example cont.50%debtM&M(Debt Policy Doesnt Matter)7Example-River Cruises-All Equity Financed-Debt replicated by investorsM&M(Debt Policy Doesnt 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 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 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 this 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 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 12C.S.&Corporate Taxes All Equity1/2 DebtEBIT1,0001,000Interest Pmt 0 100 Pretax Income1,000 900Taxes 40%400 360Net Cash Flow$600$540Total Cash Flow All Equity=600*1/2 Debt=640*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?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 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 PV 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 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-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)Investment&FinancingInteractionMiles and Ezzell 46Adjusted Present ValueAdjusted Discount RateWeighted Average Cost of CapitalInvestment&FinancingInteraction 47After Tax WACCThe 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 48After Tax WACCTax 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 book and market value balance sheets,what is the tax adjusted WACC?50After Tax WACCExample-Sangria Corporation-continued 51After Tax WACCExample-Sangria Corporation-continuedMARKET VALUES 52After Tax WACCExample-Sangria Corporation-continuedDebt ratio=(D/V)=50/125=.4 or 40%Equity ratio=(E/V)=75/125=.6 or 60%53After Tax WACCExample-Sangria Corporation-continued 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 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?56After 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?REMEMBERCash Flow is BIAT=Before interest after taxes 57After Tax WACCPreferred stock and other forms of financing must be included in the formula 58After Tax WACCExample-Sangria Corporation-continuedCalculate WACC given preferred stock is$25 mil of total equity and yields 10%.59Tricks of the TradeWhat should be included with debt?Long-term debt?Short-term debt?Cash(netted off?)Receivables?Deferred tax?60Tricks of the TradeHow are costs of financing determined?Return on equity can be derived from market dataCost of debt is set by the market given the specific rating of a firms debtPreferred stock often has a preset dividend rate 61演讲完毕，谢谢观看！