MM Irrelevance Theorem- Firm Value and WACC independent of Capital Structure- Capital Structure does not matter- Pie Model. -Problem: No prescription to.

Slides:

Advertisements

Similar presentations

Capital Structure Debt versus Equity. Advantages of Debt Interest is tax deductible (lowers the effective cost of debt) Debt-holders are limited to a.

Advertisements

The McGraw-Hill Companies, Inc., 2000

Corporate Financing and investment Decisions when Firms Have Information That Investors Do Not Have James Song Jan 30, 2007.

Chapter 16: Limits to the use of debt policy

Chapter 17 Limits to the Use of Debt

Effects of Default and Bankruptcy in a Perfect Market (no costs of financial distress) There are no effects of default and bankruptcy on firm value in.

Capital Structure Decisions: Part I

Dividend Policy: Theory

Capital Structure: Part 2 For 9.220, Term 1, 2002/03 02_Lecture20.ppt Student Version.

Capital Structure and Firm Value. Does Capital Structure affect value? Empirical patterns Empirical patterns –Across Industries –Across Firms –Across.

LOGO Financial Contracting OLIVER HART Presented by: Xulei Ruan.

Payout Policy Advanced Corporate Finance 2 October 2007.

Advanced Corporate Finance Lecture 08.1 and 09 Capital Structure and Bond Valuation (Continued) Fall, 2010.

1 Today Capital structure M&M theorem Leverage, risk, and WACC Taxes and Financial distress, Reading Brealey and Myers, Chapter 17, 18.

Corporate Finance Lecture 9.

Capital Structure (Ch. 12)

© K. Cuthbertson and D. Nitzsche Figures for Chapter 11 VALUING FIRMS : CAPITAL STRUCTURE AND THE COST OF CAPITAL (Investments : Spot and Derivatives Markets)

Chapter 12 Capital Structure  Quick Review of Capital Markets  Benefits of Borrowing  Pecking Order Hypothesis  Modigliani and Miller Optimal Capital.

Corporate Finance Lecture 17 INTRODUCTION TO CAPITAL STRUCTURE (continued) Ronald F. Singer FINA 4330 Fall, 2010.

Capital Structure: Making the Right Decision

The prime aim Make you acquainted to the contractual approach to agency problems.

Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure Jensen and Meckling, JFE, 1976 About 3400 citations.

FINANCE IN A CANADIAN SETTING Sixth Canadian Edition Lusztig, Cleary, Schwab.

FIN 614: Financial Management Larry Schrenk, Instructor.

The McGraw-Hill Companies, Inc., 2000

Chapter 9 Capital Structure © 2005 Thomson/South-Western.

Advanced Corporate Finance FINA 7330 Capital Structure Issues and Financing Fall, 2006.

Capital Structure Decisions

Miller Modigliani- MM Theory

Tam Lai Ying Law Tsz Yeung Au Man Hung

Click here for title Capital Structure: Limits to the Use of Debt.

Asymmetric information and Capital Structure In contrast to the agency costs problem, here the way of financing does not affect managerial actions. However,

Chapter 16 Capital Structure.

Capital Structure Decisions: The Basics

Does Debt Policy Matter ? Principles of Corporate Finance Seventh Edition Richard A. Brealey Stewart C. Myers Slides by Matthew Will Chapter 17 McGraw.

Chapter 18 Principles PrinciplesofCorporateFinance Tenth Edition How Much Should A Corporation Borrow? Slides by Matthew Will Copyright © 2010 by The McGraw-Hill.

Cost of Capital Professor Ronald Miolla. Agenda 1) What is Cost of Capital? 2) How to compute Cost of Capital. 3) Cost of debt. 4) Cost of equity.

Development of Capital Structure Theory n PRE-MM THEORIES Net Income (NI) Theory Net Income (NI) Theory Net Operating Income (NOI) Theory Net Operating.

Chapter 18 Principles of Corporate Finance Eighth Edition How Much Should a Firm Borrow? Slides by Matthew Will Copyright © 2006 by The McGraw-Hill Companies,

Financing decisions (2) Class 16 Financial Management,

© 2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible Web site, in whole or in part.

Finance Theory II (15.402) – Spring 2003 – Dirk Jenter Capital Structure: Informational and Agency Considerations.

ALL RIGHTS RESERVED No part of this document may be reproduced without written approval from Limkokwing University of Creative Technology 1-1 Chapter 10.

CHAPTER SIXTEEN Capital Structure By J.D. Han. Evaluation of Capital Structures A capital structure that maximizes share prices generally will minimize.

1 Survey evidence on some of the factors that affect the decision to issue debt. The survey is based on the responses of 392 CFOs, conducted by John Graham.

6- 1 Outline 6: Capital Structure 6.1 Debt and Value in a Tax Free Economy 6.2 Capital Structure and Corporate Taxes 6.3 Cost of Financial Distress 6.4.

Finance (Basic) Ludek Benada Department of Finance Office 533

Capital Structure II: Limits to the Use of Debt. Costs of Financial Distress Bankruptcy risk versus bankruptcy cost. The possibility of bankruptcy has.

Chapter 12 Capital Structure 1. Learning Outcomes Chapter 12  Describe how business risk and financial risk can affect a firm’s capital structure. 

Chapter 17 Principles of Corporate Finance Eighth Edition Does Debt Policy Matter? Slides by Matthew Will Copyright © 2006 by The McGraw-Hill Companies,

Market Liquidity & Performance Monitoring Holmstrom & Tirole (1993) By James Song Feb 4, 2007.

MODIGLIANI – MILLER THEOREM ANASTASIIA TISETSKA. AGENDA:  MODIGLIANI–MILLER I – LEVERAGE, ARBITRAGE AND FIRM VALUE  MODIGLIANI–MILLER II – LEVERAGE,

CHAPTER SIXTEEN Capital Structure By J.D. Han. Evaluation of Capital Structures A capital structure that maximizes share prices generally will minimize.

Does Debt Policy Matter?

Does Debt Policy Matter?

Paper F9 Financial Management

Capital Structure © 2005 Thomson/South-Western.

INTRODUCTION TO CAPITAL STRUCTURE (continued)

Wrap-Up of the Financing Module

Advanced Corporate Finance

FINA 4330 The Weighted Average Cost of Capital Lecture 21 Fall, 2010

Dividend Signalling/Free cash flow Model.

Capital Structure Decisions

Chapter 9 Theory of Capital Structure

Capital Structure: Limits to the Use of Debt

Capital Structure Decisions: The Basics

Capital Structure Determination

Capital structure (Chapter 15)

The composition of long-term finance used by the firm

Capital Structure Decisions: Part I

Presentation transcript:

MM Irrelevance Theorem- Firm Value and WACC independent of Capital Structure- Capital Structure does not matter- Pie Model. -Problem: No prescription to firms on how to finance projects. -Introduce tax relief on debt => 100% debt! -Personal Taxes. -Bankruptcy Costs. -Traditional View.

MM assumed- Unselfish Manager, acting in shareholders interests. - Symmetric Info between managers and investors (no inside info). Reasons for Optimal Capital Structure. Selfish Manager – Private Benefits, lack of effort etc. Asymmetric Information- Manager knows more about his firm than the outside investors.

Agency Costs (Selfish Manager). Jensen and Meckling (1976). If firm issues equity (reduced managerial ownership of firm value), Manager pursues private benefits (private jet, plush offices, time off to play golf), reducing firm value. -If firm issues debt, manager has incentive to take risky projects (risk-shifting). Trade-off: Optimal Capital Structure. D/E V* D/E*

Agency Costs (continued). Hart (1984)- Effort Level. Equity holders are soft- Manager can reduce effort. Debt holders can liquidate the firm=> Bankruptcy => manager losing job. This threat may lead to manager working harder => Increasing firm value. Therefore, increasing debt increases firm value.

Agency Costs- Continued. Free cashflow (Jensen 1986). -Managers may have pet negative NPV projects. Equity => free cashflow => managers can take these bad projects => firm value falling. Debt => reduces free cashflow. Managers cannot take the bad projects => Firm value rises. - Important in Mergers- See 4 th year course.

Asymmetric Information. Manager has inside information. Issuing debt or equity may reveal this information to the market. Myers-Majluf. -Firm has 50/50 chance of good or bad news. Market values this firm at an average. Then Manager observes this news – market does not. If bad news arrives, firm is currently overvalued in the market – manager will issue shares – This signals bad news, and share price falls. If Good news arrives, firm is undervalued in the market, and manager will not issue shares. Therefore, Issuing equity signals bad news, firm value falls.

Asymmetric Information (continued). Ross (1977)- Debt has bankruptcy threat. Manager has compensation based on firm value, but is penalised financially if firm goes bankrupt. Market cannot observe whether manager is good or bad. Good manager issues debt- signals that he is not too worried about bankruptcy – therefore, firm value rises. Bad Manager is worried about bankruptcy- does not issue debt. Firm Value falls. Empirical Evidence- Issuing equity causes firm value to fall- Debt causes firm value to rise- contrary to MM. Agency Costs and Signalling are explored in more detail in 4 th YR.

Practical Methods (Damadoran): -Trade-off Models. -Pecking Order Theory: Retained Earnings/ Debt/ equity. -Life-cycle model: Young firms less debt? Older firms more debt? -Benchmarking.