EMBA in Management & Finance. Corporate Finance. Eric Jondeau


 Andra Strickland
 3 years ago
 Views:
Transcription
1 EMBA in Management & Finance Corporate Finance
2 EMBA in Management & Finance Lecture 4: Capital Structure Limits to the Use of Debt
3 Outline 1. Costs of Financial Distress 2. Description of Costs 3. Can Costs of Debt Be Reduced? 4. Integration of Tax Effects and Financial Distress Costs 5. The PeckingOrder Theory 6. Growth and the DebtEquity Ratio 7. Personal Taxes 8. How Firms Establish Capital Structure 9. Summary and Conclusions EMBA 3/29
4 1. Costs of Financial Distress Bankruptcy risk versus bankruptcy cost. The possibility of bankruptcy has a negative effect on the value of the firm. However, it is not the risk of bankruptcy itself that lowers value. Rather it is the costs associated with bankruptcy. It is the stockholders who bear these costs. EMBA 4/29
5 2. Description of Costs Direct Costs Legal and administrative costs (tend to be a small percentage of firm value). Indirect Costs Impaired ability to conduct business (e.g., lost sales) Agency Costs Selfish strategy 1: Incentive to take large risks Selfish strategy 2: Incentive toward underinvestment Selfish strategy 3: Milking the property EMBA 5/29
6 Balance Sheet for a Company in Distress Assets BV MV Liabilities BV MV Cash $200 $200 LT bonds $300 $200 Fixed Asset $400 $0 Equity $300 $0 Total $600 $200 Total $600 $200 What happens if the firm is liquidated today? The bondholders get $200. The shareholders get nothing. EMBA 6/29
7 Selfish Strategy 1: Take Large Risks The Gamble Probability Payoff Win Big 10% $1,000 Lose Big 90% $0 Cost of investment is $200 (all the firm s cash). Required return is 50%. Expected CF from the Gamble = $1, $0 = $100 $100 NPV= $200 + = $ EMBA 7/29
8 Selfish Strategy 1: Take Large Risks Expected CF from the Gamble To Bondholders = $ $0 = $30 To Stockholders = ($1000 $300) $0 = $70 PV of Bonds Without the Gamble = $200 PV of Stocks Without the Gamble = $0 PV of Bonds With the Gamble: PV of Stocks With the Gamble: $30 $20 = 1.5 $70 $47 = 1.5 Selfish Stockholders Accept Negative NPV Project with Large Risks. EMBA 8/29
9 Selfish Strategy 2: Underinvestment Consider a governmentsponsored project that guarantees $350 in one period Cost of investment is $300 (the firm only has $200 now) so the stockholders will have to supply an additional $100 to finance the project. Required return is 10% Should we accept or reject? $350 NPV= $300 + = $ EMBA 9/29
10 Selfish Strategy 2: Underinvestment Expected CF from the government sponsored project: To Bondholder = $300 To Stockholder = ($350 $300) = $50 PV of Bonds Without the Project = $200 PV of Stocks Without the Project = $0 PV of Bonds With the Project: PV of Stocks With the Project: $ $300 = 1.1 $50 $54.55 = $ Selfish Stockholders Forego Positive NPV Project. EMBA 10/29
11 Selfish Strategy 3: Milking the Property Liquidating dividends Suppose our firm paid out a $200 dividend to the shareholders. This leaves the firm insolvent, with nothing for the bondholders, but plenty for the former shareholders. Such tactics often violate bond indentures. Increase perquisites to shareholders and/or management EMBA 11/29
12 3. Can Costs of Debt Be Reduced? Protective Covenants Debt Consolidation: If we minimize the number of parties, contracting costs fall. EMBA 12/29
13 Protective Covenants Agreements to protect bondholders Negative covenant: Thou shalt not: Pay dividends beyond specified amount. Sell more senior debt & amount of new debt is limited. Refund existing bond issue with new bonds paying lower interest rate. Buy another company s bonds. Positive covenant: Thou shall: Use proceeds from sale of assets for other assets. Allow redemption in event of merger or spinoff. Maintain good condition of assets. Provide audited financial information. EMBA 13/29
14 4. Integration of Tax Effects and Financial Distress Costs There is a tradeoff between the tax advantage of debt and the costs of financial distress. It is difficult to express this with a precise and rigorous formula. EMBA 14/29
15 Integration of Tax Effects and Financial Distress Costs Value of firm (V) Present value of tax shield on debt V L = V U + τ C B Value of firm under MM with corporate taxes and debt Maximum firm value Present value of financial distress costs V = Actual value of firm V U = Value of firm with no debt 0 B * Optimal amount of debt Debt (B) EMBA 15/29
16 The Pie Model Revisited Taxes and bankruptcy costs can be viewed as just another claim on the cash flows of the firm. Let G and L stand for payments to the government and bankruptcy lawyers, respectively. V T = S + B + G + L B L S G The essence of the MM intuition is that V T depends on the cash flow of the firm; capital structure just slices the pie. EMBA 16/29
17 5. The PeckingOrder Theory Theory stating that firms prefer to issue debt rather than equity if internal finance is insufficient. Rule 1: Use internal financing first. Rule 2: Issue debt next, equity last. The peckingorder Theory is at odds with the tradeoff theory: There is no target D/E ratio. Profitable firms use less debt. Companies like financial flexibility EMBA 17/29
18 6. Growth and the DebtEquity Ratio Growth implies significant equity financing, even in a world with low bankruptcy costs. Thus, highgrowth firms will have lower debt ratios than lowgrowth firms. Growth is an essential feature of the real world; as a result, 100% debt financing is suboptimal. EMBA 18/29
19 7. Personal Taxes: The Miller Model The Miller Model shows that the value of a levered firm can be expressed in terms of an unlevered firm as: where: (1 τ C )(1 τ S ) VL = VU + 1 B (1 τ B ) τ S = personal tax rate on equity income τ B = personal tax rate on bond income τ C = corporate tax rate EMBA 19/29
20 Personal Taxes: The Miller Model Shareholders in a levered firm receive Bondholders receive ( EBIT r B) (1 τ ) (1 τ ) r B (1 τ ) B C S Total cash flow to all stakeholders: ( EBIT r B) (1 τ ) (1 τ ) + r B (1 τ ) B C S B B B B This can be rewritten as EBIT (1 τ C ) (1 τ S ) + rb B (1 τ B ) 1 (1 τ C ) (1 τ S ) (1 τ B ) EMBA 20/29
21 Personal Taxes: The Miller Model Total cash flow to all stakeholders in the levered firm: EBIT (1 τ C ) (1 τ S ) + rb B (1 τ B ) 1 (1 τ C ) (1 τ S ) (1 τ B ) The first term is the cash flow of an unlevered firm after all taxes. Its value = V U. The value of the sum of these two terms must be V L so that A bond is worth B. It promises to pay r B B (1 τ B ) after taxes. Thus the value of the second term is: (1 τ C ) (1 τ S ) 1 B 1 τ B (1 τc)(1 τs) VL = VU + 1 B (1 τb) EMBA 21/29
22 Personal Taxes: The Miller Model Thus the Miller Model shows that the value of a levered firm can be expressed in terms of an unlevered firm as: (1 τc )(1 τ S ) VL = VU + 1 B (1 τ B ) In the case where τ B = τ s, we return to MM with only corporate tax: VL = VU +τ CB EMBA 22/29
23 Effect on Financial Leverage on Firm Value with Different Taxes Value of firm (V) (1 τc )(1 τ S ) VL = VU + 1 B (1 τ B ) V L = V U + τ C B when τ S =τ B V L < V U + τ C B when τ S < τ B but (1 τ B ) > (1 τ C ) (1 τ S ) V U V L =V U when (1 τ B ) = (1 τ C ) (1 τ S ) V L < V U when (1 τ B ) < (1 τ C ) (1 τ S ) Debt (B) EMBA 23/29
24 Integration of Personal and Corporate Tax Effects and Financial Distress Costs and Agency Costs Value of firm (V) Maximum firm value Present value of tax shield on debt Present value of financial distress costs Value of firm under MM with corporate taxes and debt V L = V U + τ C B V L < V U + τ C B when τ S < τ B but (1 τ B ) > (1 τ C ) (1 τ S ) V U = Value of firm with no debt V = Actual value of firm Agency Cost of Equity Agency Cost of Debt 0 B* Optimal amount of debt Debt (B) EMBA 24/29
25 8. How Firms Establish Capital Structure Most corporations have low DebtAsset ratios. Changes in financial leverage affect firm value. Stock price increases with increases in leverage and viceversa; this is consistent with MM with taxes. Another interpretation is that firms signal good news when they lever up. There are differences in capital structure across industries. There is evidence that firms behave as if they had a target Debt to Equity ratio. EMBA 25/29
26 How Firms Establish Capital Structure Capital structure ratios for selected US nonfinancial firms: Debt as % of market value of Equity + Debt (5year averages) High Leverage Hotel and lodging Building construction Paper Air transport Low Leverage Computers Apparel Drugs Biological products EMBA 26/29
27 Factors in Target D/E Ratio Taxes If corporate tax rates are higher than bondholder tax rates, there is an advantage to debt. Types of Assets The costs of financial distress depend on the types of assets the firm has. Uncertainty of Operating Income Even without debt, firms with uncertain operating income have high probability of experiencing financial distress. EMBA 27/29
28 9. Summary and Conclusions Costs of financial distress cause firms to restrain their issuance of debt. Direct costs Lawyers and accountants fees Indirect Costs Impaired ability to conduct business Incentives to take on risky projects Incentives to underinvest Incentive to milk the property Three techniques to reduce these costs are: Protective covenants Repurchase of debt prior to bankruptcy Consolidation of debt EMBA 28/29
29 Summary and Conclusions Debttoequity ratios vary across industries. Factors in Target D/E Ratio Taxes If corporate tax rates are higher than bondholder tax rates, there is an advantage to debt. Types of Assets The costs of financial distress depend on the types of assets the firm has. Uncertainty of Operating Income Even without debt, firms with uncertain operating income have high probability of experiencing financial distress. EMBA 29/29
Chapter 17 Capital Structure Limits to the Use of Debt
University of Science and Technology Beijing Dongling School of Economics and management Chapter 17 Capital Structure Limits to the Use of Debt Dec. 2012 Dr. Xiao Ming USTB 1 Key Concepts and Skills Define
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 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 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 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 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 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 informationCapital Structure: Informational and Agency Considerations
Capital Structure: Informational and Agency Considerations The Big Picture: Part I  Financing A. Identifying Funding Needs Feb 6 Feb 11 Case: Wilson Lumber 1 Case: Wilson Lumber 2 B. Optimal Capital Structure:
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 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 informationChapter 16 DebtEquity Mix 1. Divido Corporation is an allequity financed firm with a total market value of $100 million.
Chapter 16 DebtEquity Mix 1. Divido Corporation is an allequity financed firm with a total market value of $100 million. The company holds $10 million in cashequivalents and has $90 million in other
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 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 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 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 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 informationCapital Structure. Itay Goldstein. Wharton School, University of Pennsylvania
Capital Structure Itay Goldstein Wharton School, University of Pennsylvania 1 Debt and Equity There are two main types of financing: debt and equity. Consider a twoperiod world with dates 0 and 1. At
More informationCHAPTER 12 RISK, COST OF CAPITAL, AND CAPITAL BUDGETING
CHAPTER 12 RISK, COST OF CAPITAL, AND CAPITAL BUDGETING Answers to Concepts Review and Critical Thinking Questions 1. No. The cost of capital depends on the risk of the project, not the source of the money.
More informationFUNDING INVESTMENTS FINANCE 238/738, Spring 2008, Prof. Musto Class 6 Introduction to Corporate Bonds
FUNDING INVESTMENTS FINANCE 238/738, Spring 2008, Prof. Musto Class 6 Introduction to Corporate Bonds Today: I. Equity is a call on firm value II. Senior Debt III. Junior Debt IV. Convertible Debt V. Variance
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 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 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 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 informationHomework Assignment #1: Answer Key
Econ 497 Economics of the Financial Crisis Professor Ickes Spring 2012 Homework Assignment #1: Answer Key 1. Consider a firm that has future payoff.supposethefirm is unlevered, call the firm and its shares
More informationFNCE 301, Financial Management H Guy Williams, 2006
Stock Valuation Stock characteristics Stocks are the other major traded security (stocks & bonds). Options are another traded security but not as big as these two.  Ownership Stockholders are the owner
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 informationValueBased Management
ValueBased Management Lecture 5: Calculating the Cost of Capital Prof. Dr. Gunther Friedl Lehrstuhl für Controlling Technische Universität München Email: gunther.friedl@tum.de Overview 1. Value Maximization
More informationTHE FINANCING DECISIONS BY FIRMS: IMPACT OF CAPITAL STRUCTURE CHOICE ON VALUE
IX. THE FINANCING DECISIONS BY FIRMS: IMPACT OF CAPITAL STRUCTURE CHOICE ON VALUE The capital structure of a firm is defined to be the menu of the firm's liabilities (i.e, the "righthand side" of the
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 informationBusiness 2019 Finance I Lakehead University. Midterm Exam
Business 2019 Finance I Lakehead University Midterm Exam Philippe Grégoire Fall 2002 Time allowed: 2 hours. Instructions: Calculators are permitted. One 8.5 11 inches crib sheet is allowed. Verify that
More informationGESTÃO 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 informationFinancial ratios can be classified according to the information they provide. The following types of ratios frequently are used:
Financial Ratios Financial ratios are useful indicators of a firm's performance and financial situation. Most ratios can be calculated from information provided by the financial statements. Financial ratios
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 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 information301. CHAPTER 30 Financial Distress. Multiple Choice Questions: I. DEFINITIONS
CHAPTER 30 Financial Distress Multiple Choice Questions: I. DEFINITIONS FINANCIAL DISTRESS c 1. Financial distress can be best described by which of the following situations in which the firm is forced
More informationTotal shares at the end of ten years is 100*(1+5%) 10 =162.9.
FCS5510 Sample Homework Problems Unit04 CHAPTER 8 STOCK PROBLEMS 1. An investor buys 100 shares if a $40 stock that pays a annual cash dividend of $2 a share (a 5% dividend yield) and signs up for the
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 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 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 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 informationTPPE17 Corporate Finance 1(5) SOLUTIONS REEXAMS 2014 II + III
TPPE17 Corporate Finance 1(5) SOLUTIONS REEXAMS 2014 II III Instructions 1. Only one problem should be treated on each sheet of paper and only one side of the sheet should be used. 2. The solutions folder
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 informationSwaps: Debtequity swap
Swaps: Debtequity swap INTRODUCTION Debtequity (respectively equitydebt) swap allows a company, government, or municipality to swap debt for equity (respectively equity for debt). Debt and equity are
More informationOption Pricing Applications in Valuation!
Option Pricing Applications in Valuation! Equity Value in Deeply Troubled Firms Value of Undeveloped Reserves for Natural Resource Firm Value of Patent/License 73 Option Pricing Applications in Equity
More informationIncome Measurement and Profitability Analysis
PROFITABILITY ANALYSIS The following financial statements for Spencer Company will be used to demonstrate the calculation of the various ratios in profitability analysis. Spencer Company Comparative Balance
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 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 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 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 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 informationCHAPTER 14 COST OF CAPITAL
CHAPTER 14 COST OF CAPITAL Answers to Concepts Review and Critical Thinking Questions 1. It is the minimum rate of return the firm must earn overall on its existing assets. If it earns more than this,
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 informationDiscount rates for project appraisal
Discount rates for project appraisal We know that we have to discount cash flows in order to value projects We can identify the cash flows BUT What discount rate should we use? 1 The Discount Rate and
More informationMCQ on Financial Management
MCQ on Financial Management 1. "Shareholder wealth" in a firm is represented by: a) the number of people employed in the firm. b) the book value of the firm's assets less the book value of its liabilities
More informationInstitute of Incorporated Public Accountants. Financial Management. Module 14. May 2014. Solutions
Institute of Incorporated Public Accountants Financial Management Module 14 May 2014 Solutions Instructions: Answer five questions Section A All three questions to be attempted Section B Two of the three
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 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 informationA Primer on Valuing Common Stock per IRS 409A and the Impact of FAS 157
A Primer on Valuing Common Stock per IRS 409A and the Impact of FAS 157 By Stanley Jay Feldman, Ph.D. Chairman and Chief Valuation Officer Axiom Valuation Solutions 201 Edgewater Drive, Suite 255 Wakefield,
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 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 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 informationClass #17 Issues in Mergers and Acquisitions. 15.535  Class #17 1
Class #17 Issues in Mergers and Acquisitions 15.535  Class #17 1 Mergers & Acquisitions: The Issues Why take over another firm? What are the gains to takeovers? Strategies for Valuing Private Firms What
More informationUNIVERSITY OF WAH Department of Management Sciences
BBA330: FINANCIAL MANAGEMENT UNIVERSITY OF WAH COURSE DESCRIPTION/OBJECTIVES The module aims at building competence in corporate finance further by extending the coverage in Business Finance module to
More informationUniversity of Waterloo Midterm Examination
Student number: Student name: ANONYMOUS Instructor: Dr. Hongping Tan Duration: 1.5 hours AFM 371/2 Winter 2011 4:306:00 Tuesday, March 1 This exam has 12 pages including this page. Important Information:
More informationCHAPTER 18 Dividend and Other Payouts
CHAPTER 18 Dividend and Other Payouts Multiple Choice Questions: I. DEFINITIONS DIVIDENDS a 1. Payments made out of a firm s earnings to its owners in the form of cash or stock are called: a. dividends.
More informationCHAPTER 17 Does Debt Policy Matter?
CHPTR 17 Does Debt Policy Matter? nswers to Practice Questions 1. a. The two firms have equal value; let represent the total value of the firm. Rosencrantz could buy one percent of Company B s equity and
More informationU + PV(Interest Tax Shield)
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,
More informationAnalyzing the Statement of Cash Flows
Analyzing the Statement of Cash Flows Operating Activities NACM Upstate New York Credit Conference 2015 By Ron Sereika, CCE,CEW NACM 1 Objectives of this Educational Session u Show how the statement of
More informationProblem 1 (Issuance and Repurchase in a ModiglianiMiller World)
Problem 1 (Issuance and Repurchase in a ModiglianiMiller World) A rm has outstanding debt with a market value of $100 million. The rm also has 15 million shares outstanding with a market value of $10
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 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 informationUnderstanding Financial Information for Bankruptcy Lawyers Understanding Financial Statements
Understanding Financial Information for Bankruptcy Lawyers Understanding Financial Statements In the United States, businesses generally present financial information in the form of financial statements
More informationCorporate Finance Stephen A. Ross, Randolph W. Westerfield, Jeffrey Jaffe
Corporate Finance Stephen A. Ross, Randolph W. Westerfield, Jeffrey Jaffe Chapter 1 Introduction to Corporate Finance... 2 Chapter 2 Accounting Statements and Cash Flow... 3 Chapter 3 Financial Markets
More informationCapital Structure II
Capital Structure II Introduction In the previous lecture we introduced the subject of capital gearing. Gearing occurs when a company is financed partly through fixed return finance (e.g. loans, loan stock
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 informationWrapup of Financing. Katharina Lewellen Finance Theory II March 11, 2003
Wrapup of Financing Katharina Lewellen Finance Theory II March 11, 2003 Overview of Financing Financial forecasting Shortrun forecasting General dynamics: Sustainable growth. Capital structure Describing
More informationDiscounted Cash Flow. Alessandro Macrì. Legal Counsel, GMAC Financial Services
Discounted Cash Flow Alessandro Macrì Legal Counsel, GMAC Financial Services History The idea that the value of an asset is the present value of the cash flows that you expect to generate by holding it
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 informationNapoli Pizza wants to determine its optimal capital structure
Napoli Pizza wants to determine its optimal capital structure ABSTRACT Brad Stevenson Daniel Bauer David Collins Keith Richardson This case is based on an actual business decision that was made by a small,
More informationCost of Capital, Valuation and Strategic Financial Decision Making
Cost of Capital, Valuation and Strategic Financial Decision Making By Dr. Valerio Poti,  Examiner in Professional 2 Stage Strategic Corporate Finance The financial crisis that hit financial markets in
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 informationCorporate Bankruptcy
Corporate Bankruptcy What Every Investor Should Know... Corporate Bankruptcy What happens when a public company files for protection under the federal bankruptcy laws? Who protects the interests of investors?
More informationRatio Analysis. A) Liquidity Ratio :  1) Current ratio = Current asset Current Liability
A) Liquidity Ratio :  Ratio Analysis 1) Current ratio = Current asset Current Liability 2) Quick ratio or Acid Test ratio = Quick Asset Quick liability Quick Asset = Current Asset Stock Quick Liability
More information7 CAPITAL STRUCTURE AND FINANCIAL LEVERAGE
7 CAPITAL STRUCTURE AND FINANCIAL LEVERAGE Capital structure refers to the way a corporation finances its assets through some combination of equity and debt. A firm's capital structure is then the composition
More informationThe Value of Synergy. Aswath Damodaran 1
The Value of Synergy 1 Valuing Synergy The key to the existence of synergy is that the target firm controls a specialized resource that becomes more valuable if combined with the bidding firm's resources.
More informationCHAPTER 20: OPTIONS MARKETS: INTRODUCTION
CHAPTER 20: OPTIONS MARKETS: INTRODUCTION 1. Cost Profit Call option, X = 95 12.20 10 2.20 Put option, X = 95 1.65 0 1.65 Call option, X = 105 4.70 0 4.70 Put option, X = 105 4.40 0 4.40 Call option, X
More informationFundamentals of Corporate Finance
Fundamentals of Corporate Finance Sixth Canadian Edition by Ross, Westerfield, Jordan, and Roberts Formula Sheet page # Assets = Liabilities + Shareholders equity [2.1] 28 Revenues Expenses = Income [2.2]
More informationCorporate Capital Structure
Global Markets January 2006 Corporate Capital Structure Authors Henri Servaes Professor of Finance London Business School Peter Tufano Sylvan C. Coleman Professor of Financial Management Harvard Business
More informationISS Governance Services Proxy Research. Company Financials Compustat Data Definitions
ISS Governance Services Proxy Research Company Financials Compustat Data Definitions June, 2008 TABLE OF CONTENTS Data Page Overview 3 Stock Snapshot 1. Closing Price 3 2. Common Shares Outstanding 3 3.
More informationDiscussion Board Articles Ratio Analysis
Excellence in Financial Management Discussion Board Articles Ratio Analysis Written by: Matt H. Evans, CPA, CMA, CFM All articles can be viewed on the internet at www.exinfm.com/board Ratio Analysis Cash
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 informationThe value of tax shields is NOT equal to the present value of tax shields
The value of tax shields is NOT equal to the present value of tax shields Pablo Fernández * IESE Business School. University of Navarra. Madrid, Spain ABSTRACT We show that the value of tax shields is
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 informationFundamentals Level Skills Module, Paper F9. Section A. Mean growth in earnings per share = 100 x [(35 7/30 0) 1/3 1] = 5 97% or 6%
Answers Fundamentals Level Skills Module, Paper F9 Financial Management June 2015 Answers Section A 1 A 2 D 3 D Mean growth in earnings per share = 100 x [(35 7/30 0) 1/3 1] = 5 97% or 6% 4 A 5 D 6 B 7
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 informationFinancial Distress EC 1745. Borja Larrain
Financial Distress EC 1745 Borja Larrain Today: 1. Costs of financial distress. 2. Tradeoff theory of capital structure. 3. Empirical estimates of the costs of financial distress. 4. Bankruptcy. Readings:
More informationComputing Liquidity Ratios Current Ratio = CA / CL 708 / 540 = 1.31 times Quick Ratio = (CA Inventory) / CL (708 422) / 540 =.53 times Cash Ratio =
1 Computing Liquidity Ratios Current Ratio = CA / CL 708 / 540 = 1.31 times Quick Ratio = (CA Inventory) / CL (708 422) / 540 =.53 times Cash Ratio = Cash / CL 98 / 540 =.18 times 2 Computing Leverage
More informationThe Marginal Cost of Capital and the Optimal Capital Budget
WEB EXTENSION12B The Marginal Cost of Capital and the Optimal Capital Budget If the capital budget is so large that a company must issue new equity, then the cost of capital for the company increases.
More information