Presentation is loading. Please wait.

Presentation is loading. Please wait.

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

Published byAugusta Howard Modified over 8 years ago

Similar presentations

Presentation on theme: "Chapter 17 Principles of Corporate Finance Eighth Edition Does Debt Policy Matter? Slides by Matthew Will Copyright © 2006 by The McGraw-Hill Companies,"— Presentation transcript:

1 Chapter 17 Principles of Corporate Finance Eighth Edition Does Debt Policy Matter? Slides by Matthew Will Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved McGraw-Hill/Irwin

2 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved 17- 2 McGraw-Hill/Irwin Topics Covered  Leverage in a Competitive Tax Free Environment  Financial Risk and Expected Returns  The Weighted Average Cost of Capital  A Final Word on After Tax WACC

3 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved 17- 3 McGraw-Hill/Irwin M&M (Debt Policy Doesn’t 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.

4 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved 17- 4 McGraw-Hill/Irwin M&M (Debt Policy Doesn’t 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

5 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved 17- 5 McGraw-Hill/Irwin M&M (Debt Policy Doesn’t Matter)

6 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved 17- 6 McGraw-Hill/Irwin M&M (Debt Policy Doesn’t Matter)

7 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved 17- 7 McGraw-Hill/Irwin Example - Macbeth Spot Removers - All Equity Financed M&M (Debt Policy Doesn’t Matter) Expected outcome

8 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved 17- 8 McGraw-Hill/Irwin Example cont. 50% debt M&M (Debt Policy Doesn’t Matter)

9 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved 17- 9 McGraw-Hill/Irwin Example - Macbeth’s - All Equity Financed - Debt replicated by investors M&M (Debt Policy Doesn’t Matter)

10 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved 17- 10 McGraw-Hill/Irwin MM'S PROPOSITION I If capital markets are doing their job, firms cannot increase value by tinkering with capital structure. V is independent of the debt ratio. AN EVERYDAY ANALOGY It should cost no more to assemble a chicken than to buy one whole. No Magic in Financial Leverage

11 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved 17- 11 McGraw-Hill/Irwin Proposition I and Macbeth Macbeth continued

12 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved 17- 12 McGraw-Hill/Irwin Leverage and Returns

13 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved 17- 13 McGraw-Hill/Irwin M&M Proposition II Macbeth continued

14 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved 17- 14 McGraw-Hill/Irwin M&M Proposition II Macbeth continued

15 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved 17- 15 McGraw-Hill/Irwin Leverage and Risk Macbeth continued Leverage increases the risk of Macbeth shares

16 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved 17- 16 McGraw-Hill/Irwin Leverage and Returns Asset Value100Debt (D)40 Equity (E)60 Asset Value100Firm Value (V)100 r d = 7.5% r e = 15% Market Value Balance Sheet example

17 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved 17- 17 McGraw-Hill/Irwin Leverage and Returns Asset Value100Debt (D)40 Equity (E)60 Asset Value100Firm Value (V)100 r d = 7.5% changes to 7.875% r e = ?? Market Value Balance Sheet example – continued What happens to Re when debt costs rise?

18 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved 17- 18 McGraw-Hill/Irwin Leverage and Returns

19 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved 17- 19 McGraw-Hill/Irwin WACC  WACC is the traditional view of capital structure, risk and return.

20 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved 17- 20 McGraw-Hill/Irwin r DVDV rDrD rErE r E =WACC WACC

21 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved 17- 21 McGraw-Hill/Irwin r DEDE rDrD rErE M&M Proposition II rArA Risk free debtRisky debt

22 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved 17- 22 McGraw-Hill/Irwin r DVDV rDrD rErE WACC WACC (traditional view)

23 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved 17- 23 McGraw-Hill/Irwin r DVDV rDrD rErE WACC WACC (M&M view)

24 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved 17- 24 McGraw-Hill/Irwin After 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 tax rate. Old Formula

25 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved 17- 25 McGraw-Hill/Irwin After Tax WACC Tax Adjusted Formula

26 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved 17- 26 McGraw-Hill/Irwin After Tax WACC Example - Union Pacific The firm has a marginal tax rate of 35%. The cost of equity is 10.0% and the pretax cost of debt is 5.5%. Given the book and market value balance sheets, what is the tax adjusted WACC?

27 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved 17- 27 McGraw-Hill/Irwin After Tax WACC Example - Union Pacific - continued MARKET VALUES

28 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved 17- 28 McGraw-Hill/Irwin After Tax WACC Example - Union Pacific - continued Debt ratio = (D/V) = 7.6/22.6=.34 or 34% Equity ratio = (E/V) = 15/22.6 =.66 or 66%

29 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved 17- 29 McGraw-Hill/Irwin After Tax WACC Example - Union Pacific - continued

30 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved 17- 30 McGraw-Hill/Irwin Web Resources www.finance.yahoo.com/ www.valuepro.net Click to access web sites Internet connection required

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

Similar presentations

Debt policy 50 years hence…we shall escape the absurdity of growing a whole chicken in order to eat the breast or wing, by growing these parts separately.

Debt policy 50 years hence…we shall escape the absurdity of growing a whole chicken in order to eat the breast or wing, by growing these parts separately.
Does Debt Policy Matter?

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

Capital Structure Debt versus Equity. Advantages of Debt Interest is tax deductible (lowers the effective cost of debt) Debt-holders are limited to a.
The McGraw-Hill Companies, Inc., 2000

The McGraw-Hill Companies, Inc., 2000
Capital Structure Theory

Capital Structure Theory
Corporate Financial Theory

Corporate Financial Theory
McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved 1 Chapter 16 Assessing Long-Term Debt, Equity, and Capital Structure McGraw-Hill/Irwin.

Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved 1 Chapter 16 Assessing Long-Term Debt, Equity, and Capital Structure McGraw-Hill/Irwin.
McGraw-Hill © 2004 The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Leverage and Capital Structure Chapter 13.

McGraw-Hill © 2004 The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Leverage and Capital Structure Chapter 13.
How Much Should a Corporation Borrow?

How Much Should a Corporation Borrow?
Does Debt Policy Matter? Student Presentations Capital Structure Considerations Modigliani and Miller – Propositions 1 and 2 Financial Risk and Expected.

Does Debt Policy Matter? Student Presentations Capital Structure Considerations Modigliani and Miller – Propositions 1 and 2 Financial Risk and Expected.
Capital Structure Decision

Capital Structure Decision
Chapter 19 Principles of Corporate Finance Eighth Edition Financing and Valuation Slides by Matthew Will Copyright © 2006 by The McGraw-Hill Companies,

Chapter 19 Principles of Corporate Finance Eighth Edition Financing and Valuation Slides by Matthew Will Copyright © 2006 by The McGraw-Hill Companies,
Capital Structure MM Theory 1. Capital Structure “neither a borrower nor a lender be” (Source: Shakespeare`s Hamlet) “The firm`s mix of securities(long.

Capital Structure MM Theory 1. Capital Structure “neither a borrower nor a lender be” (Source: Shakespeare`s Hamlet) “The firm`s mix of securities(long.
Théorie Financière 2004-2005 Structure financière et coût du capital Professeur André Farber.

Théorie Financière Structure financière et coût du capital Professeur André Farber.
Financial Leverage and Capital Structure Policy

Financial Leverage and Capital Structure Policy
Théorie Financière Structure financière et coût du capital Professeur André Farber.

Théorie Financière Structure financière et coût du capital Professeur André Farber.
FINANCE 11. Capital Structure and Cost of Capital Professor André Farber Solvay Business School Université Libre de Bruxelles Fall 2007.

FINANCE 11. Capital Structure and Cost of Capital Professor André Farber Solvay Business School Université Libre de Bruxelles Fall 2007.
1 Today Capital structure M&M theorem Leverage, risk, and WACC Taxes and Financial distress, Reading Brealey and Myers, Chapter 17, 18.

1 Today Capital structure M&M theorem Leverage, risk, and WACC Taxes and Financial distress, Reading Brealey and Myers, Chapter 17, 18.
© The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill 19- 1 Topics Covered  After Tax WACC  Tricks of the Trade  Capital Structure and WACC  Adjusted.

© The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill Topics Covered  After Tax WACC  Tricks of the Trade  Capital Structure and WACC  Adjusted.

Similar presentations

Ads by Google