U + PV(Interest Tax Shield)


 Lesley Lee
 4 years ago
 Views:
Transcription
1 CHAPTER 15 Debt and Taxes Chapter Synopsis 15.1 The Interest Tax Deduction A CCorporation pays taxes on proits ater interest payments are deducted, but it pays dividends rom atertax net income. Thus, the tax code provides an incentive or the use o debt inancing. An interest tax shield is the amount a irm would have paid in taxes i it did not have interest expense. The size o the interest tax shield equals interest expense the tax rate Valuing the Interest Tax Shield The dierential taxing o interest and dividends represents a market imperection not considered in the original MM propositions. Given the availability o an interest tax shield, MM Proposition I can be restated in the presence o corporate taxes such that: The total value o the levered irm exceeds the value o the irm without leverage due to the present value o the tax savings rom debt: V = V U + PV(Interest Tax Shield) I a irm has a permanent, constant amount o debt, D, a marginal tax rate o τ c,and a riskree debt cost o capital o r = r then the interest tax shield equals: D, τ τ τ c Interest c (r D) (r = = = c D) PV(Interest Tax Shield) = τ r r r c D The tax deductibility o interest lowers the eective cost o debt inancing or the irm. I the interest on debt is tax deductible, then an interest rate r is equivalent to an eective atertax rate o r (1 τ c ). To account or the beneit o the interest tax shield, the WACC can be restated to account or the atertax cost o debt:
2 174 Berk/DeMarzo Corporate Finance, Second Edition E D rwacc = re + rd(1 τ C). E+ D E + D 15.3 Recapitalizing to Capture the Tax Shield Consider a irm that has 20 million shares outstanding, a stock price o $15, no debt, and a 35% tax rate. The irm has had consistently stable earnings and management believes that they can borrow as much as $100 million. They are considering a leveraged recapitalization in which they would use the borrowed unds to repurchase $100 million/$15 = 6.67 million shares. They expect that the tax savings rom this transaction will boost the stock price and beneit shareholders. Without leverage, the irm s market value is the value o its unlevered equity. Assuming the current stock price is the air price or the shares without leverage: U V = (20 million shares) ($15) = $300 million. With $100 million in permanent debt, the present value o the irm s uture tax savings is τ c D = 0.35($100 million) = $35 million and the levered irm value is: V = V U + PV(Interest Tax Shield) = $300 million + $35 million = $335 million. The equity value, net o the $100 million o debt, is: $235 million E = V D= $335 million $100 million = $235 million P = = $ Since the shares were repurchased at $15, the million remaining shareholders get all o the $35 million tax shield, which equals $35 million/13.33 million = $2.625 per share. More realistically, once investors know the recap will occur, the share price will rise immediately to a level that relects the $35 million value o the interest tax shield that the irm will receive, $235 million/20 million = $16.75 per share. The beneit o the interest tax shield now goes to all 20 million o the original shares outstanding or a total beneit o $1.75/share 20 million shares = $35 million Personal Taxes Personal taxes may oset the corporate tax beneits o leverage. Investors are generally taxed on interest income rom debt and dividend income rom a stock; they are also taxed on capital gains when they sell a stock but may delay incurring those taxes indeinitely. Every $1 received ater taxes by debt holders rom interest payments costs equity holders $1 (1 τ * ) on an ater tax basis, in which τ *, the eective tax advantage o debt, equals: τ τ τ τ τ τ * (1 i ) (1 c )(1 e ) (1 = c )(1 e ) = 1 (1 τi) (1 τi) whereτ e is the personal tax rate on equity income and τ i is the personal tax rate on interest * income. Now, the tax shield in a year is τ interest expense, and the value o a levered irm with permanent debt is V = V U + τ * D.
3 Berk/DeMarzo Corporate Finance, Second Edition 175 * When there are no personal taxes, or when τ e = τ i, thenτ = τ C. However, when τ e < τ i, as it is today, then τ * < τ C and there is a tax beneits o leverage Optimal Capital Structure with Taxes In recent years, U.S. irms have shown a clear preerence or debt as a source o external inancing. In act, the overall net equity issues has been negative, meaning that the value o shares that irms have bought back is greater than the value o the shares they have issued. Even though irms have not issued new equity, the market value o equity has risen over time such that average irm s debt as a raction o the irm s value has remained reasonably stable at 35% to 40%. In 2005, debt accounted or about 36% o U.S irms capital structures; however, the use o debt varied signiicantly by industry. Firms in growth industries like high technology carry very little debt, whereas airlines, automakers, and utilities, have high leverage ratios. There is no corporate tax beneit rom incurring interest payments that exceed EBIT. In act, because interest payments constitute a tax disadvantage at the investor level whenτ i > τ e, investors will pay higher individual taxes with excess leverage, making them worse o. Thus, it is optimal to borrow until interest equals EBIT to take ull advantage o the corporate tax deduction o interest, but avoid the tax disadvantage o excess leverage at the personal level. Since there are other provisions in the tax laws or deductions and tax credits, such as depreciation, investment tax credits, and operating loss carryorwards, some irms rely less heavily on the interest tax shield. However, even ater considering alternate tax shields, irms have ar less leverage than theory would predict at this point in the analysis. In the next chapter, actors that may help explain such apparently suboptimal behavior, such as bankruptcy costs, are considered. Selected Concepts and Key Terms Interest Tax Shield The amount that a irm would have paid in taxes i it did not have interest expense. The size o the interest tax shield each period equals interest expense the tax rate. Concept Check Questions and Answers With corporate income taxes, explain why a irm s value can be higher with leverage even though its earnings are lower. A irm can be better o even though its earnings are lower because the total amount available to all investors is higher with leverage. The value o a irm is the total amount it can raise rom all investors, not just equity holders. So, i the irm can pay out more in total with leverage, it will initially be able to raise more total capital What is the interest tax shield? The interest tax shield is the gain to investors rom the tax deductibility o interest payments. It is the additional amount that a irm would have paid in taxes i it did not have leverage.
4 176 Berk/DeMarzo Corporate Finance, Second Edition With corporate taxes as the only market imperection, how does the value o the irm with leverage dier rom its value without leverage? The total value o the levered irm exceeds the value o the irm without leverage due to the present value o the tax savings rom debt How does leverage aect a irm s weighted average cost o capital? Corporate taxes lower the eective cost o debt inancing, which translates into a reduction in the weighted average cost o capital. The magnitude o the reduction in the WACC is proportional to the amount o debt inancing. The higher the irm s leverage, the more the irm exploits the tax advantage o debt, and so the lower its WACC How can shareholders beneit rom a leveraged recap when it reduces the total value o equity? Although a leveraged recap reduces the total value o equity, shareholders capture the beneits o the interest tax shield upront. The stock price rises at the announcement o the recap How does the interest tax shield enter into the market value balance sheet? The total market value o a irm s securities must equal the total market value o the irm s assets. In the presence o corporate taxes, we must include the interest tax shield as one o the irm s assets on the market value balance sheet Under current law (in 2009), why is there a personal tax disadvantage o debt? Just like corporate taxes, personal taxes reduce the cash lows to investors and diminish irm value. Personal taxes thus have the potential to oset some o the corporate tax beneits o leverage. Currently, in the United States and many other countries, interest income is taxed more heavily than capital gains rom equity How does the personal tax disadvantage o debt change the value o leverage or the irm? Personal taxes oset some o the corporate tax beneits o leverage and thus reduce the value o leverage or the irm How does the growth rate o a irm aect the optimal raction o debt in the capital structure? The optimal raction o debt, as a proportion o a irm s capital structure, declines with the growth rate o the irm Do irms choose capital structures that ully exploit the tax advantages o debt? The empirical results o international leverage indicate that irms do not ully exploit the tax advantages o debt because the interest expense o the average irm is well below its taxable income Examples with StepbyStep Solutions Solving Problems Problems using this chapter s ideas oten involve calculating the atertax cost o debt, the atertax weightedaverage cost o capital, the interest tax shield, and inding the present value o the interest tax shield and the value o a levered irm. Applications include considering the consequences on shareholder value o a leveraged recapitalization, which
5 Berk/DeMarzo Corporate Finance, Second Edition 177 involves issuing debt which is then used to repurchase shares. Problems may also involve considering the eects o personal taxes. Examples 1. You are trying to decide whether your irm should use debt inancing under dierent assumptions regarding the amount o debt in its capital structure. The irm s assets will generate an expected EBIT o $800,000 per year (beginning one year rom today) in perpetuity. The irm will make no new capital or working capital investments and all assets are ully depreciated. The assets have a beta o 1.5, the riskree rate is 5%, and the market risk premium is 10%. You can issue bonds at par paying an annual coupon at a 5% annual rate. The corporate tax rate is 50%, and the irm has 100,000 shares outstanding. [A] What is the value o the irm with no debt? What is the stock value per share? What is the value o the irm i it issues $1.5 million o debt and uses the proceeds to repurchase 75,000 shares or $20 (75,000 $20 = $1.5 million)? What is the stock value per share? Should the irm issue the debt? Step 1. Determine the unlevered equity cost o capital. The equity cost o capital is ER [ ] = r + β ( ER [ ] r ) = 5% + 1.5(10%) = 20%. i Mkt i Step 2. Determine the ree cash lows o the unlevered irm. Since the irm will make no new investments and has no depreciation, FCF = NI each year. EBIT $800,000 50% 400,000 Net income 400,000 Step 3. Determine the value o the unlevered irm. FCF $400,000 Since the cash lows are a perpetuity, PV = = = $2 million r 0.20 Step 4. Determine the value per share. U V $2,000,000 Value per share = = = $20 Shares Outstanding 100,000 Step 5. Determine the value o the levered irm. U Dr ( D)( τ C) V = V + PV(Tax shield) = $2,000,000 + rd $1,500,000(0.05)(0.50) = $2,000,000 + = $2,750, Step 6. Determine the equity value per share. The total equity value is V D = $2,750,000 $1,500,000, and the number o shares repurchased is $1,500,000/$20=75,000, so: 2,750,000 1,500,000 Value per share = = $ ,000 75,000 Mkt
6 178 Berk/DeMarzo Corporate Finance, Second Edition Thus, the irm should issue the debt based on these assumptions because it leads to an $50 $20 increase in the share price o = 150%. $20 2. Wrigley Inc. had $1 billion in EBITDA in The irm is unlevered and has a market value o equity o $12 billion and a tax rate o 40%. Consider the eect on the value o the irm o the ollowing debt issuances. Assume that all proceeds will be used to buy back stock. [A] Issuing $6 billion o 8% coupon rate 5year bonds which repay the principal in 5 years. Issuing $6 billion o 8% coupon rate permanent bonds. [C] Issuing $6 billion o 8% coupon rate bonds, with amount o bonds increasing by 5% every year orever. Step 1. Determine the value o the levered irm or the 5year bonds. Since annual interest is 0.08($6 billion) = $480 million, the annual tax shield is $480 million 0.40 = $192 million or ive years. V U 1 1 = V + PV(Interest Tax Shield) = $12 billion + $192million (1.08) = $12 billion + $0.8 billion = $12.8 billion Step 2. Determine the value o the levered irm or the permanent bonds. Now, the $192 million tax shield is a perpetuity. U $192 million V = V + PV(Interest Tax Shield) = $12 billion +.08 = $12 billion billion = $14.4 billion Step 3. Determine the value o the levered irm or the bonds that increase by 5% every year orever. Now, the $14 million tax shield is the irst cash low in a growing perpetuity. U $192million V = V + PV(Interest Tax Shield) = $12 billion = $12billion billion = $18.5 billion 3. Best Buy is equally likely to have EBIT this coming year o $1 billion, $1.5 billion, or $2 billion. Its corporate tax rate is 35%, and investors pay a 15% tax rate on income rom equity and a 30% tax rate on interest income. [A] What is the eective interest tax shield (considering both personal taxes and corporate taxes) i interest expense is $500 million this year? At what level o interest expense does the eective tax advantage o debt disappear? Step 1. Determine the eective tax rate i all o the interest will be used to shield taxes. ( 1 τc)( 1 τe) ( )( ) τ* = 1 = 1 = 21.1% 1 τ i Step 2. Determine the eective tax shield i interest expense is $500,000. Tax shield = τ * Interest expense = $500,000 = $105,357
7 Berk/DeMarzo Corporate Finance, Second Edition 179 Step 3. Determine when the eective tax rate is negative by considering dierent levels o interest expense. Interest expense Probability o NI > 0 E[ τ C ] τ * $500,000, $1,000,000, $1,500,000, $2,000,000, So or an interest expense up to $1.5 billion, there is a tax advantage. For interest expense over $1.5 billion, there is an expected eective tax disadvantage or debt inancing. Questions and Problems 1. A irm expects ree cash low o $10 million each year. Its corporate tax rate is 35%, and its unlevered cost o capital is 10%. The irm also has outstanding debt o $35 million, and it expects to maintain this level o debt permanently. [A] What is the irm s value without leverage? What is the irm s value with the $35 million o debt? 2. A irm is considering permanently adding $100 million o debt to its capital structure. The corporate tax rate is 35%. [A] Absent personal taxes, what is the value o the interest tax shield rom the new debt? I investors pay a tax rate o 40% on interest income, and a tax rate o 20% on income rom dividends and capital gains, what is the value o the interest tax shield rom the new debt? 3. An unlevered irm has 50 million shares outstanding and a stock price o $20. The irm plans to unexpectedly announce that it will issue $500 million in 10% coupon rate debt inancing and use the proceeds to repurchase shares. The debt level is expected to remain at this level. The tax rate is 35%. [A] What is the irm s market value beore the announcement? [C] What is the market value o the irm ater the repurchase? What is the share value ater the repurchase assuming that the shares can be repurchased at $20 per share? 4. Suppose the corporate tax rate is 35%, and investors pay a tax rate o 15% on income rom dividends or capital gains and a tax rate o 28% on interest income. Your irm plans to issue $1 billion in perpetual 10% coupon bonds. The irm has historically paid all net income out as dividends; however, in order to pay this interest expense, the irm will cut its dividend. [A] How much will bondholders receive ater paying taxes on the interest they earn? By how much will the irm need to cut its dividend each year to pay this interest expense? [C] By how much will this cut in the dividend reduce equity holders annual atertax income? [D] How much less will the government receive in total tax revenues each year? [E] What is the eective tax advantage o debt with this amount o leverage? 5. Your unlevered irm will have a certain EBIT every year o $80 million. Every year it will spend $10 million on capital expenditures, invest $10 million in net working capital, and have $28 million in depreciation. The corporate tax rate is 35%, and the irm s cost o capital is 11%. [A] I the irm s ree cash low is expected to grow by 5% per year, what is the value o its equity today?
8 180 Berk/DeMarzo Corporate Finance, Second Edition I the debt cost o capital is 10%, what amount o borrowing would maximize the value o the irm? What would the value o the irm be then? Solutions to Questions and Problems 1. [A] U 10 V = = $100 million 0.10 U V = V + τ D = = $110.5 million C 2. [A] PV(Interest Tax Shield) = τ C D = 35% 100 = $35 million. ( )( ) τ* = 1 = 13.33% PV(Interest Tax Shield) = τc D = 13.33% 100 = $13.33 million 3. [A] V U = $20 50 million = $1 billion V = V U + PV(Tax Shield) = $1 billion + $500 million(0.10)(0.35) =$175 million 0.10 = $1.175 billion. [C] E = V D = $1.175 billion $500 million = $675 million 500 million They will repurchase $ = 25 millionshares. $20 $1.175 billion 500 million The share price is thus = =$ million 25 million 4. [A] $100 million (1.28) = $72 million each year An interest expense o $100 million per year reduces net income by 100(1.35) = $65 million ater corporate taxes. So, dividends will be $65 million less. [C] [D] $65 million dividend cut $65 (1.15) = $55.25 million per year. Interest taxes = million = $28 million ess corporate taxes = million= $35 million ess dividend taxes = million = $9.75 million Government tax revenues change by = $16.75 million ( )( ) [E] τ* = 1 = 23.3% [A] FCF = EBIT ( 1 τ ) + Dep Capex Δ NWC = 80 ( ) = $60 U 60 V = E = = $1 billion The irm can pay $80 million in interest, so it can borrow: $80 million = $800 million at 10% $800 million(0.10)(0.35) V = $1 billion + = $1.28 billion 0.10
GESTÃO FINANCEIRA II PROBLEM SET 5 SOLUTIONS (FROM BERK AND DEMARZO S CORPORATE FINANCE ) LICENCIATURA UNDERGRADUATE COURSE
GESTÃO FINANCEIRA II PROBLEM SET 5 SOLUTIONS (FROM BERK AND DEMARZO S CORPORATE FINANCE ) LICENCIATURA UNDERGRADUATE COURSE 1 ST SEMESTER 20102011 Chapter 18 Capital Budgeting and Valuation with Leverage
More informationChapter 14 Capital Structure in a Perfect Market
Chapter 14 Capital Structure in a Perfect Market 141. Consider a project with free cash flows in one year of $130,000 or $180,000, with each outcome being equally likely. The initial investment required
More informationDUKE UNIVERSITY Fuqua School of Business. FINANCE 351  CORPORATE FINANCE Problem Set #4 Prof. Simon Gervais Fall 2011 Term 2.
DUK UNIRSITY Fuqua School of Business FINANC 351  CORPORAT FINANC Problem Set #4 Prof. Simon Gervais Fall 2011 Term 2 Questions 1. Suppose the corporate tax rate is 40%. Consider a firm that earns $1,000
More informationCHAPTER 16. Financial Distress, Managerial Incentives, and Information. Chapter Synopsis
CHAPTER 16 Financial Distress, Managerial Incentives, and Information Chapter Synopsis In the previous two chapters it was shown that, in an otherwise perfect capital market in which firms pay taxes, the
More informationUse the table for the questions 18 and 19 below.
Use the table for the questions 18 and 19 below. The following table summarizes prices of various defaultfree zerocoupon bonds (expressed as a percentage of face value): Maturity (years) 1 3 4 5 Price
More information1 Pricing options using the Black Scholes formula
Lecture 9 Pricing options using the Black Scholes formula Exercise. Consider month options with exercise prices of K = 45. The variance of the underlying security is σ 2 = 0.20. The risk free interest
More informationLeverage and Capital Structure
Leverage and Capital Structure Ross Chapter 16 Spring 2005 10.1 Leverage Financial Leverage Financial leverage is the use of fixed financial costs to magnify the effect of changes in EBIT on EPS. Fixed
More informationDUKE UNIVERSITY Fuqua School of Business. FINANCE 351  CORPORATE FINANCE Problem Set #7 Prof. Simon Gervais Fall 2011 Term 2.
DUKE UNIVERSITY Fuqua School of Business FINANCE 351  CORPORATE FINANCE Problem Set #7 Prof. Simon Gervais Fall 2011 Term 2 Questions 1. Suppose the corporate tax rate is 40%, and investors pay a tax
More informationCHAPTER 15 Capital Structure: Basic Concepts
Multiple Choice Questions: CHAPTER 15 Capital Structure: Basic Concepts I. DEFINITIONS HOMEMADE LEVERAGE a 1. The use of personal borrowing to change the overall amount of financial leverage to which an
More informationCost of Capital and Project Valuation
Cost of Capital and Project Valuation 1 Background Firm organization There are four types: sole proprietorships partnerships limited liability companies corporations Each organizational form has different
More informationMM1  The value of the firm is independent of its capital structure (the proportion of debt and equity used to finance the firm s operations).
Teaching Note Miller Modigliani Consider an economy for which the Efficient Market Hypothesis holds and in which all financial assets are possibly traded (abusing words we call this The Complete Markets
More informationIf you ignore taxes in this problem and there is no debt outstanding: EPS = EBIT/shares outstanding = $14,000/2,500 = $5.60
Problems Relating to Capital Structure and Leverage 1. EBIT and Leverage Money Inc., has no debt outstanding and a total market value of $150,000. Earnings before interest and taxes [EBIT] are projected
More informationSOLUTIONS. Practice questions. Multiple Choice
Practice questions Multiple Choice 1. XYZ has $25,000 of debt outstanding and a book value of equity of $25,000. The company has 10,000 shares outstanding and a stock price of $10. If the unlevered beta
More informationFinance 2 for IBA (30J201) F. Feriozzi Resit exam June 18 th, 2012. Part One: MultipleChoice Questions (45 points)
Finance 2 for IBA (30J201) F. Feriozzi Resit exam June 18 th, 2012 Part One: MultipleChoice Questions (45 points) Question 1 Assume that capital markets are perfect. Which of the following statements
More informationChapter 17 Corporate Capital Structure Foundations (Sections 17.1 and 17.2. Skim section 17.3.)
Chapter 17 Corporate Capital Structure Foundations (Sections 17.1 and 17.2. Skim section 17.3.) The primary focus of the next two chapters will be to examine the debt/equity choice by firms. In particular,
More informationE. V. Bulyatkin CAPITAL STRUCTURE
E. V. Bulyatkin Graduate Student Edinburgh University Business School CAPITAL STRUCTURE Abstract. This paper aims to analyze the current capital structure of Lufthansa in order to increase market value
More informationChapter 17 Does Debt Policy Matter?
Chapter 17 Does Debt Policy Matter? Multiple Choice Questions 1. When a firm has no debt, then such a firm is known as: (I) an unlevered firm (II) a levered firm (III) an allequity firm D) I and III only
More informationLECTURE 4. Valuing stocks Berk, De Marzo Chapter 9
1 LECTURE 4 Valuing stocks Berk, De Marzo Chapter 9 2 The Dividend Discount Model A OneYear Investor Potential Cash Flows Dividend Sale of Stock Timeline for OneYear Investor Since the cash flows are
More informationChapter 16 Financial Distress, Managerial Incentives, and Information
Chapter 16 Financial Distress, Managerial Incentives, and Information 161. Gladstone Corporation is about to launch a new product. Depending on the success of the new product, Gladstone may have one of
More informationt = 1 2 3 1. Calculate the implied interest rates and graph the term structure of interest rates. t = 1 2 3 X t = 100 100 100 t = 1 2 3
MØA 155 PROBLEM SET: Summarizing Exercise 1. Present Value [3] You are given the following prices P t today for receiving risk free payments t periods from now. t = 1 2 3 P t = 0.95 0.9 0.85 1. Calculate
More informationEquity Analysis and Capital Structure. A New Venture s Perspective
Equity Analysis and Capital Structure A New Venture s Perspective 1 Venture s Capital Structure ASSETS Short term Assets Cash A/R Inventories Long term Assets Plant and Equipment Intellectual Property
More informationThe Adjusted Present Value Approach to Valuing Leveraged Buyouts 1
Chapter 17 Valuation and Capital Budgeting for the Levered Firm 17A1 Appendix 17A The Adjusted Present Value Approach to Valuing Leveraged Buyouts 1 Introduction A leveraged buyout (LBO) is the acquisition
More informationThe Adjusted Present Value Approach to Valuing Leveraged Buyouts 1 Introduction
Chapter 18 Valuation and Capital Budgeting for the Levered Firm 18A1 Appendix 18A The Adjusted Present Value Approach to Valuing Leveraged Buyouts 1 Introduction A leveraged buyout (LBO) is the acquisition
More informationChapter 7. . 1. component of the convertible can be estimated as 1100796.15 = 303.85.
Chapter 7 71 Income bonds do share some characteristics with preferred stock. The primary difference is that interest paid on income bonds is tax deductible while preferred dividends are not. Income bondholders
More informationChapter 14 Assessing LongTerm Debt, Equity, and Capital Structure
I. Capital Structure (definitions) II. MM without Taxes (1958) III. MM with Taxes (1963) Chapter 14 Assessing LongTerm Debt, Equity, and Capital Structure IV. Financial Distress V. Business Risk VI. Financial
More informationLeverage. FINANCE 350 Global Financial Management. Professor Alon Brav Fuqua School of Business Duke University. Overview
Leverage FINANCE 35 Global Financial Management Professor Alon Brav Fuqua School of Business Duke University Overview Capital Structure does not matter! Modigliani & Miller propositions Implications for
More informationFinancial Markets and Valuation  Tutorial 6: SOLUTIONS. Capital Structure and Cost of Funds
Financial Markets and Valuation  Tutorial 6: SOLUTIONS Capital Structure and Cost of Funds (*) denotes those problems to be covered in detail during the tutorial session (*) Problem 1. (Ross, Westerfield
More informationCorporate Finance & Options: MGT 891 Homework #6 Answers
Corporate Finance & Options: MGT 891 Homework #6 Answers Question 1 A. The APV rule states that the present value of the firm equals it all equity value plus the present value of the tax shield. In this
More information1. What is a recapitalization? Why is this considered a pure capital structure change?
CHAPTER 12 CONCEPT REVIEW QUESTIONS 1. What is a recapitalization? Why is this considered a pure capital structure change? Recapitalization is an alteration of a company s capital structure to change the
More informationHHIF Lecture Series: Discounted Cash Flow Model
HHIF Lecture Series: Discounted Cash Flow Model Alexander Remorov University of Toronto November 19, 2010 Alexander Remorov (University of Toronto) HHIF Lecture Series: Discounted Cash Flow Model 1 / 18
More informationCHAPTER 20. Hybrid Financing: Preferred Stock, Warrants, and Convertibles
CHAPTER 20 Hybrid Financing: Preferred Stock, Warrants, and Convertibles 1 Topics in Chapter Types of hybrid securities Preferred stock Warrants Convertibles Features and risk Cost of capital to issuers
More informationCh. 18: Taxes + Bankruptcy cost
Ch. 18: Taxes + Bankruptcy cost If MM1 holds, then Financial Management has little (if any) impact on value of the firm: If markets are perfect, transaction cost (TAC) and bankruptcy cost are zero, no
More informationThe AdjustedPresentValue Approach to Valuing Leveraged Buyouts 1)
IE Aufgabe 4 The AdjustedPresentValue Approach to Valuing Leveraged Buyouts 1) Introduction A leveraged buyout (LBO) is the acquisition by a small group of equity investors of a public or private company
More informationProblem 1 Problem 2 Problem 3
Problem 1 (1) Book Value Debt/Equity Ratio = 2500/2500 = 100% Market Value of Equity = 50 million * $ 80 = $4,000 Market Value of Debt =.80 * 2500 = $2,000 Debt/Equity Ratio in market value terms = 2000/4000
More informationPractice Exam (Solutions)
Practice Exam (Solutions) June 6, 2008 Course: Finance for AEO Length: 2 hours Lecturer: Paul Sengmüller Students are expected to conduct themselves properly during examinations and to obey any instructions
More informationCHAPTER 8. Problems and Questions
CHAPTER 8 Problems and Questions 1. Plastico, a manufacturer of consumer plastic products, is evaluating its capital structure. The balance sheet of the company is as follows (in millions): Assets Liabilities
More informationCFAspace. CFA Level II. Provided by APF. Academy of Professional Finance 专 业 金 融 学 院
CFAspace Provided by APF CFA Level II Equity Investments Free Cash Flow Valuation Part I CFA Lecturer: Hillary Wang Content Free cash flow to the firm, free cash flow to equity Ownership perspective implicit
More informationCorporate Finance: Final Exam
Corporate Finance: Final Exam Answer all questions and show necessary work. Please be brief. This is an open books, open notes exam. 1. DayTop Inns is a publicly traded company, with 10 million shares
More informationFIN 413 Corporate Finance. Capital Structure, Taxes, and Bankruptcy
FIN 413 Corporate Finance Capital Structure, Taxes, and Bankruptcy Evgeny Lyandres Fall 2003 1 Relaxing the MM Assumptions E D T Interest payments to bondholders are deductible for tax purposes while
More informationCorporate Finance: Final Exam
Corporate Finance: Final Exam Answer all questions and show necessary work. Please be brief. This is an open books, open notes exam. For partial credit, when discounting, please show the discount rate
More informationCHAPTER 17. Payout Policy. Chapter Synopsis
CHAPTER 17 Payout Policy Chapter Synopsis 17.1 Distributions to Shareholders A corporation s payout policy determines if and when it will distribute cash to its shareholders by issuing a dividend or undertaking
More informationChapter 7: Capital Structure: An Overview of the Financing Decision
Chapter 7: Capital Structure: An Overview of the Financing Decision 1. Income bonds are similar to preferred stock in several ways. Payment of interest on income bonds depends on the availability of sufficient
More informationRisk and Return: Estimating Cost of Capital
Lecture: IX 1 Risk and Return: Estimating Cost o Capital The process: Estimate parameters or the riskreturn model. Estimate cost o equity. Estimate cost o capital using capital structure (leverage) inormation.
More informationCHAPTER 2 ACCOUNTING STATEMENTS, TAXES, AND CASH FLOW
CHAPTER 2 ACCOUNTING STATEMENTS, TAXES, AND CASH FLOW Answers to Concepts Review and Critical Thinking Questions 1. True. Every asset can be converted to cash at some price. However, when we are referring
More informationThe cost of capital. A reading prepared by Pamela Peterson Drake. 1. Introduction
The cost of capital A reading prepared by Pamela Peterson Drake O U T L I N E 1. Introduction... 1 2. Determining the proportions of each source of capital that will be raised... 3 3. Estimating the marginal
More informationMBA (3rd Sem) 201314 MBA/29/FM302/T/ODD/1314
Full Marks : 70 MBA/29/FM302/T/ODD/1314 201314 MBA (3rd Sem) Paper Name : Corporate Finance Paper Code : FM302 Time : 3 Hours The figures in the righthand margin indicate marks. Candidates are required
More informationFinding the Right Financing Mix: The Capital Structure Decision
Finding the Right Financing Mix: The Capital Structure Decision Aswath Damodaran Stern School of Business Aswath Damodaran 1 First Principles Invest in projects that yield a return greater than the minimum
More informationThings to Absorb, Read, and Do
Things to Absorb, Read, and Do Things to absorb  Everything, plus remember some material from previous chapters. This chapter applies Chapter s 6, 7, and 12, Risk and Return concepts to the market value
More informationFINC 3630: Advanced Business Finance Additional Practice Problems
FINC 3630: Advanced Business Finance Additional Practice Problems Accounting For Financial Management 1. Calculate free cash flow for Home Depot for the fiscal yearended February 1, 2015 (the 2014 fiscal
More informationPart 9. The Basics of Corporate Finance
Part 9. The Basics of Corporate Finance The essence of business is to raise money from investors to fund projects that will return more money to the investors. To do this, there are three financial questions
More informationCopyright 2009 Pearson Education Canada
The consequence of failing to adjust the discount rate for the risk implicit in projects is that the firm will accept highrisk projects, which usually have higher IRR due to their highrisk nature, and
More informationChapter 9 Valuing Stocks
Chapter 9 Valuing Stocks 91. Assume Evco, Inc., has a current price of $50 and will pay a $2 dividend in one year, and its equity cost of capital is 15%. What price must you expect it to sell for right
More informationSAMPLE FACT EXAM (You must score 70% to successfully clear FACT)
SAMPLE FACT EXAM (You must score 70% to successfully clear FACT) 1. What is the present value (PV) of $100,000 received five years from now, assuming the interest rate is 8% per year? a. $600,000.00 b.
More informationChapter 15: Debt Policy
FIN 302 Class Notes Chapter 15: Debt Policy Two Cases: Case one: NO TAX All Equity Half Debt Number of shares 100,000 50,000 Price per share $10 $10 Equity Value $1,000,000 $500,000 Debt Value $0 $500,000
More informationChapter 1: The ModiglianiMiller Propositions, Taxes and Bankruptcy Costs
Chapter 1: The ModiglianiMiller Propositions, Taxes and Bankruptcy Costs Corporate Finance  MSc in Finance (BGSE) Albert BanalEstañol Universitat Pompeu Fabra and Barcelona GSE Albert BanalEstañol
More informationFinancial Markets and Valuation  Tutorial 5: SOLUTIONS. Capital Asset Pricing Model, Weighted Average Cost of Capital & Practice Questions
Financial Markets and Valuation  Tutorial 5: SOLUTIONS Capital sset Pricing Model, Weighted verage Cost o Capital & Practice Questions (*) denotes those problems to be covered in detail during the tutorial
More informationCAPITAL STRUCTURE [Chapter 15 and Chapter 16]
Capital Structure [CHAP. 15 & 16] 1 CAPITAL STRUCTURE [Chapter 15 and Chapter 16] CONTENTS I. Introduction II. Capital Structure & Firm Value WITHOUT Taxes III. Capital Structure & Firm Value WITH Corporate
More informationComprehensive exam Feb.11
Comprehensive exam Feb.11 1 Objectives of the examination Apply the financial management concept to evaluate the company s performance. Relate the results of the analysis to make financial decisions or
More informationTest3. Pessimistic Most Likely Optimistic Total Revenues 30 50 65 Total Costs 2520 15
Test3 1. The market value of Charcoal Corporation's common stock is $20 million, and the market value of its riskfree debt is $5 million. The beta of the company's common stock is 1.25, and the market
More informationIESE UNIVERSITY OF NAVARRA OPTIMAL CAPITAL STRUCTURE: PROBLEMS WITH THE HARVARD AND DAMODARAN APPROACHES. Pablo Fernández*
IESE UNIVERSITY OF NAVARRA OPTIMAL CAPITAL STRUCTURE: PROBLEMS WITH THE HARVARD AND DAMODARAN APPROACHES Pablo Fernández* RESEARCH PAPER No 454 January, 2002 * Professor of Financial Management, IESE Research
More informationACCOUNTING III Cash Flow Statement & Linking the 3 Financial Statements. Fall 2015 Comp Week 5
ACCOUNTING III Cash Flow Statement & Linking the 3 Financial Statements Fall 2015 Comp Week 5 CODE: CA$H Administrative Stuff Send an email to trentnelson@college.harvard.edu if you have not been added
More informationEMBA in Management & Finance. Corporate Finance. Eric Jondeau
EMBA in Management & Finance Corporate Finance EMBA in Management & Finance Lecture 5: Capital Budgeting For the Levered Firm Prospectus Recall that there are three questions in corporate finance. The
More information3. If an individual investor buys or sells a currently owned stock through a broker, this is a primary market transaction.
Spring 2012 Finance 3130 Sample Exam 1A Questions for Review 1. The form of organization for a business is an important issue, as this decision has very significant effect on the income and wealth of the
More informationLOS 42.a: Define and interpret free cash flow to the firm (FCFF) and free cash flow to equity (FCFE).
The following is a review of the Equity Investments principles designed to address the learning outcome statements set forth by CFA Institute. This topic is also covered in: Free Cash Flow Valuation This
More informationINTERVIEWS  FINANCIAL MODELING
420 W. 118th Street, Room 420 New York, NY 10027 P: 2128544613 F: 2128546190 www.sipa.columbia.edu/ocs INTERVIEWS  FINANCIAL MODELING Basic valuation concepts are among the most popular technical
More informationCorporate Finance, Fall 03 Exam #2 review questions (full solutions at end of document)
Corporate Finance, Fall 03 Exam #2 review questions (full solutions at end of document) 1. Portfolio risk & return. Idaho Slopes (IS) and Dakota Steppes (DS) are both seasonal businesses. IS is a downhill
More informationMGT201 Solved MCQs(500) By
MGT201 Solved MCQs(500) By http://www.vustudents.net Why companies invest in projects with negative NPV? Because there is hidden value in each project Because there may be chance of rapid growth Because
More informationFinding the Right Financing Mix: The Capital Structure Decision. Aswath Damodaran 1
Finding the Right Financing Mix: The Capital Structure Decision Aswath Damodaran 1 First Principles Invest in projects that yield a return greater than the minimum acceptable hurdle rate. The hurdle rate
More informationValue of Equity and Per Share Value when there are options and warrants outstanding. Aswath Damodaran
Value of Equity and Per Share Value when there are options and warrants outstanding Aswath Damodaran 1 Equity Value and Per Share Value: A Test Assume that you have done an equity valuation of Microsoft.
More informationThe DebtEquity Trade Off: The Capital Structure Decision
The DebtEquity Trade Off: The Capital Structure Decision Aswath Damodaran Stern School of Business Aswath Damodaran 1 First Principles Invest in projects that yield a return greater than the minimum acceptable
More informationFIN 423/523 Recapitalizations
FIN 423/523 Recapitalizations DebtforEquity Swaps EquityforDebt Swaps Calls of Convertible Securities to Force Conversion optimal conversion policy Asymmetric Information What Is a Recapitalization
More informationEMBA in Management & Finance. Corporate Finance. Eric Jondeau
EMBA in Management & Finance Corporate Finance EMBA in Management & Finance Lecture 4: Capital Structure Limits to the Use of Debt Outline 1. Costs of Financial Distress 2. Description of Costs 3. Can
More informationClick Here to Buy the Tutorial
FIN 534 Week 4 Quiz 3 (Str) Click Here to Buy the Tutorial http://www.tutorialoutlet.com/fin534/fin534week4quiz3 str/ For more course tutorials visit www.tutorialoutlet.com Which of the following
More informationThe Assumptions and Math Behind WACC and APV Calculations
The Assumptions and Math Behind WACC and APV Calculations Richard Stanton U.C. Berkeley Mark S. Seasholes U.C. Berkeley This Version October 27, 2005 Abstract We outline the math and assumptions behind
More informationTIP If you do not understand something,
Valuing common stocks Application of the DCF approach TIP If you do not understand something, ask me! The plan of the lecture Review what we have accomplished in the last lecture Some terms about stocks
More informationLeveraged Buyout Model Quick Reference
Leveraged Buyout (LBO) Model Overview A leveraged buyout model shows what happens when a private equity firm acquires a company using a combination of equity (cash) and debt, and then sells it in 35 years.
More informationAdvanced Corporate Finance. 2. Financial Planning, from Accounting to Free Cash Flows
Advanced Corporate Finance 2. Financial Planning, from Accounting to Free Cash Flows Objectives of the session 1. Show how to use accounting information to compute cash flows 2. Understand and compute
More informationManagement Accounting Financial Strategy
PAPER P9 Management Accounting Financial Strategy The Examiner provides a short study guide, for all candidates revising for this paper, to some first principles of finance and financial management Based
More informationInvestment Analysis (FIN 670) Fall 2009. Homework 5
Investment Analysis (FIN 670) Fall 009 Homework 5 Instructions: please read careully You should show your work how to get the answer or each calculation question to get ull credit The due date is Tuesday,
More informationChapter 17: Financial Statement Analysis
FIN 301 Class Notes Chapter 17: Financial Statement Analysis INTRODUCTION Financial ratio: is a relationship between different accounting items that tells something about the firm s activities. Purpose
More informationFORMULA SHEET [3.2] 63
FORMULA SHEET Assets = Liabilities + Shareholders equity [2.1] 26 Revenues  Expenses = Income [2.2] 30 Cash flow from assets = Cash flow to bondholders + Cash flow to shareholders [2.3] 32 Current ratio
More informationVALUATION JC PENNEY (NYSE:JCP)
VALUATION JC PENNEY (NYSE:JCP) Prepared for Dr. K.C. Chen California State University, Fresno Prepared by Sicilia Sendjaja Finance 129Student Investment Funds December 15 th, 2009 California State University,
More informationChapters 3 and 13 Financial Statement and Cash Flow Analysis
Chapters 3 and 13 Financial Statement and Cash Flow Analysis Balance Sheet Assets Cash Inventory Accounts Receivable Property Plant Equipment Total Assets Liabilities and Shareholder s Equity Accounts
More informationCash Flow Analysis Venture Business Perspective
Cash Flow Analysis Venture Business Perspective Cash Flow (CF) Analysis What is CF and how is determined? CF Free CF Managing CF Cash Conversion Cyclical CF Breakeven Valuing venture businesses based
More informationChapter 13, ROIC and WACC
Chapter 13, ROIC and WACC Lakehead University Winter 2005 Role of the CFO The Chief Financial Officer (CFO) is involved in the following decisions: Management Decisions Financing Decisions Investment Decisions
More informationBA 351 CORPORATE FINANCE. John R. Graham Adapted from S. Viswanathan LECTURE 10 THE ADJUSTED NET PRESENT VALUE METHOD
BA 351 CORPORATE FINANCE John R. Graham Adapted from S. Viswanathan LECTURE 10 THE ADJUSTED NET PRESENT VALUE METHOD FUQUA SCHOOL OF BUSINESS DUKE UNIVERSITY 1 THE ADJUSTED NET PRESENT VALUE METHOD COPING
More informationUSING THE EQUITY RESIDUAL APPROACH TO VALUATION: AN EXAMPLE
Graduate School of Business Administration  University of Virginia USING THE EQUITY RESIDUAL APPROACH TO VALUATION: AN EXAMPLE Planned changes in capital structure over time increase the complexity of
More informationMBA Finance PartTime Financial Statement Analysis and Cash Flows
MBA Finance PartTime Financial Statement Analysis and Cash Flows Professor Hugues Pirotte Spéder 1 1 Levers of Performance Return on Equity Return on Invested Capital Leverage Profit Margin Asset Turnover
More informationVALUATIONS I Financial Metrics, Ratios, & Comparables Analysis. Fall 2015 Comp Week 6
VALUATIONS I Financial Metrics, Ratios, & Comparables Analysis Fall 2015 Comp Week 6 CODE: COMPS Timeline Date Topic 9/10/15 Introduction to Finance 9/17/15 Qualitative Analysis: SWOT and Porter s Five
More informationChapter 6 The cash flow statement
Chapter 6 The cash flow statement The last four chapters have been spent looking at the balance sheet and income statement and how to use them. In this chapter, we will move on to arguably the most revealing
More informationActuarial Society of India
Actuarial Society of India Examination November 2006 CT2: Finance and Financial Reporting Indicative Solutions Page 1 of 7 Solution 110 Sol 1 Sol 2 Sol 3 Sol 4 Sol 5 Sol 6 Sol 7 Sol 8 Sol 9 Sol 10 E E
More informationFinancial Statement Analysis!
Financial Statement Analysis! The raw data for investing Aswath Damodaran! 1! Questions we would like answered! Assets Liabilities What are the assets in place? How valuable are these assets? How risky
More informationExcellence in Financial Management. Prepared by: Matt H. Evans, CPA, CMA, CFM
Excellence in Financial Management Course 6: The Management of Capital Prepared by: Matt H. Evans, CPA, CMA, CFM This course provides an overview of concepts related to the management of capital. This
More informationValuing Companies. Katharina Lewellen Finance Theory II May 5, 2003
Valuing Companies Katharina Lewellen Finance Theory II May 5, 2003 Valuing companies Familiar valuation methods Discounted Cash Flow Analysis Comparables Real Options Some new issues Do we value assets
More informationOften stock is split to lower the price per share so it is more accessible to investors. The stock split is not taxable.
Reading: Chapter 8 Chapter 8. Stock: Introduction 1. Rights of stockholders 2. Cash dividends 3. Stock dividends 4. The stock split 5. Stock repurchases and liquidations 6. Preferred stock 7. Analysis
More informationChapter 5 Valuing Stocks
Chapter 5 Valuing Stocks MULTIPLE CHOICE 1. The first public sale of company stock to outside investors is called a/an a. seasoned equity offering. b. shareholders meeting. c. initial public offering.
More informationReturn on Equity has three ratio components. The three ratios that make up Return on Equity are:
Evaluating Financial Performance Chapter 1 Return on Equity Why Use Ratios? It has been said that you must measure what you expect to manage and accomplish. Without measurement, you have no reference to
More informationOklahoma State University Spears School of Business. Financial Statements
Oklahoma State University Spears School of Business Financial Statements Slide 2 Sources of Information Annual reports (10K) & Quarterly reports (10Q) SEC EDGAR Major databases COMPUSTAT(access through
More informationCHAPTER 13 Capital Structure and Leverage
CHAPTER 13 Capital Structure and Leverage Business and financial risk Optimal capital structure Operating Leverage Capital structure theory 1 What s business risk? Uncertainty about future operating income
More information