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Click to edit Master title style,Click to edit Master text styles,Second level,Third level,Fourth level,Fifth level,*,*,Click to edit Master title style,Click to edit Master text styles,Second level,Third level,Fourth level,Fifth level,The McGraw-Hill Companies,Inc.,2001,15-,*,Irwin/McGraw-Hill,Irwin/McGraw-Hill,Chapter 15,Fundamentals of Corporate Finance,Third Edition,The Capital Structure Decision,Brealey Myers Marcus,slides by Matthew Will,Irwin/McGraw-Hill,The McGraw-Hill Companies,Inc.,2001,Topics Covered,Debt and Value in a Tax Free Economy,Capital Structure and Corporate Taxes,Cost of Financial Distress,Explaining Financial Choices,M&M,(Debt Policy Doesnt 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 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,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),Weighted Average Cost of Capital,without taxes(traditional view),r,D,V,r,D,r,E,Includes Bankruptcy Risk,WACC,Weighted Average Cost of Capital,without taxes(M&M view),r,D,V,r,D,r,E,Includes Bankruptcy Risk,WACC,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,C.S.&Corporate Taxes,All Equity1/2 Debt,EBIT1,0001,000,Interest Pmt,0 100,Pretax Income1,000 900,Taxes 40%,400 360,Net 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 r,D,x Tc,r,D,=,D x Tc,Example:,Tax benefit=1000 x(.10)x(.40)=$40,PV of 40 perpetuity=40/.10 =$400,PV Tax Shield=D x Tc=1000 x.4 =,$400,Capital Structure,Firm Value=,Value of All Equity Firm+PV Tax Shield,Example,All Equity Value=600/.10=6,000,PV Tax Shield =400,Firm Value with 1/2 Debt=$6,400,Financial Distress,Costs of Financial Distress,-Costs arising from bankruptcy or distorted business decisions before bankruptcy.,Market Value=Value if all Equity Financed,+PV Tax Shield,-PV Costs of Financial Distress,Financial Distress,Debt,Market Value of The Firm,Value of,unlevered,firm,PV of interest,tax shields,Costs of,financial distress,Value of levered firm,Optimal amount,of debt,Maximum value of firm,Financial Choices,Trade-off Theory,-Theory that capital structure is based on a trade-off between tax savings and distress costs of debt.,Pecking Order Theory,-Theory stating that firms prefer to issue debt rather than equity if internal finance is insufficient.,9,、静夜四无邻，荒居旧业贫。,2024/11/28,2024/11/28,Thursday,November 28,2024,10,、雨中黄叶树，灯下白头人。,2024/11/28,2024/11/28,2024/11/28,11/28/2024 5:01:54 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