Chapter 15 Capital Structure Decisions: Part 1
|
|
- Marcus Hopkins
- 7 years ago
- Views:
Transcription
1 Chapter 15 Capital Structure Decisions: Part 1 ANSWERS TO END-OF-CHAPTER QUESTIONS 15-1 a. Capital structure is the manner in which a firm s assets are financed; that is, the righthand side of the balance sheet. Capital structure is normally expressed as the percentage of each type of capital used by the firm--debt, preferred stock, and common equity. Business risk is the risk inherent in the operations of the firm, prior to the financing decision. Thus, business risk is the uncertainty inherent in a total risk sense, future operating income, or earnings before interest and taxes (EBIT). Business risk is caused by many factors. Two of the most important are sales variability and operating leverage. Financial risk is the risk added by the use of debt financing. Debt financing increases the variability of earnings before taxes (but after interest); thus, along with business risk, it contributes to the uncertainty of net income and earnings per share. Business risk plus financial risk equals total corporate risk. b. Operating leverage is the extent to which fixed costs are used in a firm s operations. If a high percentage of a firm s total costs are fixed costs, then the firm is said to have a high degree of operating leverage. Operating leverage is a measure of one element of business risk, but does not include the second major element, sales variability. Financial leverage is the extent to which fixed-income securities (debt and preferred stock) are used in a firm s capital structure. If a high percentage of a firm s capital structure is in the form of debt and preferred stock, then the firm is said to have a high degree of financial leverage. The breakeven point is that level of unit sales at which costs equal revenues. Breakeven analysis may be performed with or without the inclusion of financial costs. If financial costs are not included, breakeven occurs when EBIT equals zero. If financial costs are included, breakeven occurs when EBT equals zero Operating leverage affects EBIT and, through EBIT, EPS. Financial leverage has no effect on EBIT--it only affects EPS, given EBIT If sales tend to fluctuate widely, then cash flows and the ability to service fixed charges will also vary. Such a firm is said to have high business risk. Consequently, there is a relatively large risk that the firm will be unable to meet its fixed charges, and interest payments are fixed charges. As a result, firms in unstable industries tend to use less debt than those whose sales are subject to only moderate fluctuations The tax benefits from debt increase linearly, which causes a continuous increase in the firm s value and stock price. However, financial distress costs get higher and higher as more and more debt is employed, and these costs eventually offset and begin to outweigh the benefits of debt.
2 SOLUTIONS TO END-OF-CHAPTER PROBLEMS 15-9 a. Present situation (50% debt): wd rd(1-t) + wcers (0.5)(10%)(1-0.15) + (0.5)(14%) 11.25%. V FCF (EBIT)(1 T) ($13.24)(1 0.15) $100 million. 70 percent debt: wd rd(1-t) + wcers (0.7)(12%)(1-0.15) + (0.3)(16%) 11.94%. V FCF (EBIT)(1 T) ($13.24)(1 0.15) $ million. 30 percent debt: wd rd(1-t) + wcers (0.3)(8%)(1-0.15) + (0.7)(13%) 11.14%. V FCF (EBIT)(1 T) ($13.24)(1 0.15) $ million a. BEA s unlevered beta is bub/(1+ (1-T)(D/S))1.0/(1+(1-0.40)(20/80)) b. b bu (1 + (1-T)(D/S)). At 40 percent debt: bl 0.87 ( (40%/60%)) rs (4) % c. wd rd(1-t) + wcers (0.4)(9%)(1-0.4) + (0.6)(10.872%) 8.683%. V FCF (EBIT)(1 T) ($14.933)(1 0.4) $ million
3 15-11 Tax rate 40% rrf 5.0% bu 0.8 rm rrf 6.0% From data given in the problem and table we can develop the following table: Levered wd wce D/S rd rd(1 T) beta a rs b c 0 100% % 3.60% % 9.80% % % 4.20% % 9.26% % % 4.80% % 8.95% % % 5.40% % 8.89% % % 6.00% % 9.06% Notes: a These beta estimates were calculated using the Hamada equation, b bu[1 + (1 T)(D/S)]. b These rs estimates were calculated using the CAPM, rs rrf + (rm rrf)b. c These estimates were calculated with the following equation: wd(rd)(1 T) + (wce)(rs). The firm s optimal capital structure is that capital structure which minimizes the firm s. The is minimized at a capital structure consisting of 60% debt and 40% equity. At that capital structure, the firm s is 8.89%.
4 Chapter 16 Capital Structure Decisions: Part II ANSWERS TO END-OF-CHAPTER QUESTIONS 16-4 The value of a growing tax shield is greater than the value of a constant tax shield. This means that for a given initial level of debt a growing firm will have more value from the debt tax shield than a non-growing firm. Thus for a given face value of debt, D, and unlevered value of equity, U, a growing firm will have a smaller wd, a larger levered cost of equity, rel, and a larger. So the MM model will underestimate the value of the levered firm and its cost of equity and. SOLUTIONS TO END-OF-CHAPTER PROBLEMS 16-4 a. bl bu[1 + (1 - T)(D/S)]. bu b L 1 (1 T)(D /S) (1 0.4)(0.5/ 0.5) b. rsu rrf + (rm - rrf)bu 10% + (5%) % % %. c. $2 Million Debt: VL VU + TD $ ($2) $10.5 million. rsl rsu + (rsu - rrf)(1 - T)(D/S) % + (15.625% - 10%)(0.75)($2/$8.5) % (0.75)($2/$8.5) 16.62%. $4 Million Debt: VL $ ($4) $11.0 million. rsl % %(0.75)($4/$7) 18.04%. $6 Million Debt: VL $ ($6) $11.5 million. rsl % % (0.75)($6/$5.5) 20.23%.
5 d. $6 Million Debt: VL $ ($6) $10.4 million. rsl % %(0.60)($6/$4.4) 20.23%. The mathematics of MM result in the required return, and, thus, the same financial risk premium. However, the market value debt ratio has increased from $6/$ % to $6/$ % at the higher tax rate. Hence, a higher tax rate reduces the financial risk premium at a given market value debt/equity ratio. This is because a higher tax rate increases the relative benefits of debt financing a. VU EBIT $2 million r su $20 million. b. rsu 10.0%. (Given) rsl rsu + (rsu - rd)(d/s) 10% + (10% - 5%)($10/$10) 15.0%. c. SL EBIT rd D rsl $ ($10) 0.15 $10 million. SL + D VL VU + TD. $10 + $10 $20 VL $20 + (0)$10 $20 million. d. U rsu 10%. For Firm L, we know that must equal rsu 10% according to Proposition I. But, we can demonstrate this as follows: L (D/V)rd + (S/V)rs ($10/$20)5% + ($10/$20)15% 2.5% + 7.5% 10.0%.
6 e. VL $22 million is not an equilibrium value according to MM. Here s why. Suppose you owned 10 percent of Firm L s equity, worth 0.10($22 million - $10 million) $1.2 million. Your cash flow is equal to 10% of the dividends paid by the levered firm. Because it is a zero-growth firm, its dividends are equal to its net income: Dividends Net income EBIT rdd $2,000, ($1,000,000) $1,500,000. Your 10% share is 0.10($1,500,000) $150,000. Therefore, your annual cash flow is $150,000. Now consider the following strategy. You could (1) sell your stock in firm L for 0.10($2 million) $1.2 million. Then you could borrow an amount (at 5%) equal to 10 percent of Firm L s debt, or 0.10($10 million) $1 million. You would have $1.2 million + $1 million $2.2 million. You could spend $2 million of this to buy 10% of Firm U s stock, and invest the remaining $200,000 in risk-free debt. Your cash stream would now be: (a) 10 percent of firm U s diviedends, which is $200,000: 0.10(EBITU) 0.10($2 million) $200,000; plus (b) the return on the extra $200,000 profit you invested in risk-free debt, which is $10,000: rd(profit) 0.05($200,000) $10,000; minus (c) the interest expense on the $1 million you borrowed, which is $50,000: rd(loan) 0.05($1 million)] $50,000. Your net cash flow from this strategy is $200,000 + $10,000 - $50,000 $160,000. Since the second strategy produces $160,000 annually while your position in L produces only $150,000, all investors would prefer the second strategy. The pressure to sell L s stock would cause its price to fall, and the pressure to buy U s stock would cause its price to increase. This would continue until VL VU a. VU EBIT(1 T) r su $ 2(1 0.4) 0.10 $12 million. VL VU + TD $12 + (0.4)$10 $16 million. b. rsu %. rsl rsu + (rsu - rd)(1 - T)(D/S) 10% + (10% - 5%)(0.6)($10/$6) 10% + 5% 15.0%. c. SL ( EBIT rd D)(1 T) rsl [$ ($10)] $6 million. VL SL + D $6 + $10 $16 million. d. U rsu 10.00%. L (D/V)rd(1 - T) + (S/V)rs ($10/$16)5%(0.6) + ($6/$16)15% 7.50%.
7 16-9 a. VU SU EBIT $1,600, r su $14,545,455. VL VU $14,545,455. b. At D $0: rs 11.0%; 11.0% At D $6 million: rsl rsu + (rsu rd)(d/s) $6,000,000 11% + (11% - 6%) $8,545,455 11% % 14.51%. (D/V)rd + (S/V)rs $6,000,000 $8,545,455 6% % $14,545,455 $14,545, %. At D $10 million: $10,000,000 rsl 11% + 5% $4,545, %. $10,000,000 $4,545,455 6% + 22% $14,545,455 $14,545, %. Leverage has no effect on firm value, which is a constant $14,545,455 since is a constant 11%. This is because the cost of equity is increasing with leverage, and this increase exactly offsets the advantage of using lower cost debt financing. c. VU [(EBIT - I)(1 - T)]/rsU [($1,600,000-0)(0.6)]/0.11 $8,727,273. VL VU + TD $8,727, ($6,000,000) $11,127,273
8 d. At D $0: rs 11.0%. 11.0%. At D $6 million: VL VU + TD $8,727, ($6,000,000) $11,127,273. rsl rsu + (rsu - rd)(1 - T)(D/S) 11% + (11% - 6%)(0.6)($6,000,000/$5,127,273) 14.51%. (D/V)rd(1 - T) + (S/V)rs ($6,000,000/$11,127,273)(6%)(0.6) + ($5,127,273/$11,127,273)(14.51%) 8.63%. At D $10 million: VL $8,727, ($10,000,000) $12,727,273. rsl 11% + 5%(0.6)($10,000,000/$2,727,273) 22.00%. ($10,000,000/$12,727,273)(6%)(0.6) + ($2,727,273/$12,727,273)(22%) 7.54%. Summary: (in millions) D V D/V rs $ 0 $ % 11.0% 11.0% Value (Millions of Dollars) D/V (%)
9 e. The maximum amount of debt financing is 100 percent. At this level D V, and hence VL VU + TD D $8,727, D D D - 0.4D $8,727, D $8,727,273 D $8,727,273/0.6 $14,545,455 V. Since the bondholders are bearing the same risk as the equity holders of the unlevered firm, rd is now 11 percent. Now, the total interest payment is $14,545,455(0.11) $1.6 million, and the entire $1.6 million of EBIT would be paid out as interest. Thus, the investors (bondholders) would get $1.6 million per year, and it would be capitalized at 11 percent: VL $1,600, $14,545,455. Cost of Capital (%) 25 k S rs krd(1-t) d D/V (%) f. (1) Rising interest rates would cause rd and hence rd(1 - T) to increase, pulling up. These changes would cause V to rise less steeply, or even to decline. (2) Increased riskiness causes rs to rise faster than predicted by MM. Thus, would increase and V would decrease.
Leverage. 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 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 all-equity firm D) I and III only
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 informationChapter 14 Capital Structure in a Perfect Market
Chapter 14 Capital Structure in a Perfect Market 14-1. 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 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 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 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 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 #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 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 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 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 default-free zero-coupon bonds (expressed as a percentage of face value): Maturity (years) 1 3 4 5 Price
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 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 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 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 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 2010-2011 Chapter 18 Capital Budgeting and Valuation with Leverage
More informationChapter 14 Assessing Long-Term Debt, Equity, and Capital Structure
I. Capital Structure (definitions) II. MM without Taxes (1958) III. MM with Taxes (1963) Chapter 14 Assessing Long-Term Debt, Equity, and Capital Structure IV. Financial Distress V. Business Risk VI. Financial
More informationTest3. Pessimistic Most Likely Optimistic Total Revenues 30 50 65 Total Costs -25-20 -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 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 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 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 20: OPTIONS MARKETS: INTRODUCTION
CHAPTER 20: OPTIONS MARKETS: INTRODUCTION PROBLEM SETS 1. Options provide numerous opportunities to modify the risk profile of a portfolio. The simplest example of an option strategy that increases risk
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 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 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 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 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 informationENTREPRENEURIAL FINANCE: Strategy Valuation and Deal Structure
ENTREPRENEURIAL FINANCE: Strategy Valuation and Deal Structure Chapter 9 Valuation Questions and Problems 1. You are considering purchasing shares of DeltaCad Inc. for $40/share. Your analysis of the company
More informationHow to Estimate the Effect of a Stock Repurchase on Share Price
How to Estimate the Effect of a Stock Repurchase on Share Price By Dilip D. Kare and C. Don Wiggins Management Accounting May 1987 What is the smallest amount of stock you need to repurchase in order to
More informationA Test Of The M&M Capital Structure Theories Richard H. Fosberg, William Paterson University, USA
A Test Of The M&M Capital Structure Theories Richard H. Fosberg, William Paterson University, USA ABSTRACT Modigliani and Miller (1958, 1963) predict two very specific relationships between firm value
More informationCOST OF CAPITAL. Please note that in finance, we are concerned with MARKET VALUES (unlike accounting, which is concerned with book values).
COST OF CAPITAL Cost of capital calculations are a very important part of finance. To value a project, it is important to discount the cash flows using a discount rate that incorporates the debt-equity
More informationStock Valuation: Gordon Growth Model. Week 2
Stock Valuation: Gordon Growth Model Week 2 Approaches to Valuation 1. Discounted Cash Flow Valuation The value of an asset is the sum of the discounted cash flows. 2. Contingent Claim Valuation A contingent
More informationU + PV(Interest Tax Shield)
CHAPTER 15 Debt and Taxes Chapter Synopsis 15.1 The Interest Tax Deduction A C-Corporation pays taxes on proits ater interest payments are deducted, but it pays dividends rom ater-tax net income. Thus,
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 informationMBA 8230 Corporation Finance (Part II) Practice Final Exam #2
MBA 8230 Corporation Finance (Part II) Practice Final Exam #2 1. Which of the following input factors, if increased, would result in a decrease in the value of a call option? a. the volatility of the company's
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 informationTPPE17 Corporate Finance 1(5) SOLUTIONS RE-EXAMS 2014 II + III
TPPE17 Corporate Finance 1(5) SOLUTIONS RE-EXAMS 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 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 informationFinancial Management Sample paper 1
Financial Management Sample paper 1 Time: 3 hours Maxi Mark 100 General Instructions 1. Answers to questions carrying 1 mark may be from one word to one sentence. 2. Answers to questions carrying 3 marks
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 year-ended February 1, 2015 (the 2014 fiscal
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 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 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 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 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 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 informationMidterm Exam:Answer Sheet
Econ 497 Barry W. Ickes Spring 2007 Midterm Exam:Answer Sheet 1. (25%) Consider a portfolio, c, comprised of a risk-free and risky asset, with returns given by r f and E(r p ), respectively. Let y be the
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 informationValue-Based Management
Value-Based 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 informationSOLUTIONS EXAM 2013-10-25 WRITE AS CLEARLY AND DISTINCTLY AS POSSIBLE!
SOLUTIONS EXAM 2013-10-25 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 must be handed in before you leave
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 informationThe Cost of Capital. Chapter 10. Cost of Debt (r d ) The Cost of Capital. Calculating the cost of obtaining funds for a project
The Cost of Capital Chapter 10 (def) - Cost of obtaining money to fund asset purchase - use as estimate of r (discount rate) If we can earn more than the cost of capital (r) from a project than company
More informationCost of Capital - WACC Mobile networks
ITU EXPERT-LEVEL TRAINING ON NETWORK COST MODELING FOR ASIA AND PACIFIC COUNTRIES LEVEL II Cost of Capital - WACC Mobile networks Bangkok, Thailand 15-19 November 2010 Note: The views expressed in this
More informationThe Tangent or Efficient Portfolio
The Tangent or Efficient Portfolio 1 2 Identifying the Tangent Portfolio Sharpe Ratio: Measures the ratio of reward-to-volatility provided by a portfolio Sharpe Ratio Portfolio Excess Return E[ RP ] r
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 informationFinance Homework p. 65 (3, 4), p. 66-69 (1, 2, 3, 4, 5, 12, 14), p. 107 (2), p. 109 (3,4)
Finance Homework p. 65 (3, 4), p. 66-69 (1, 2, 3, 4, 5, 12, 14), p. 107 (2), p. 109 (3,4) Julian Vu 2-3: Given: Security A Security B r = 7% r = 12% σ (standard deviation) = 35% σ (standard deviation)
More informationChapter 16 Debt-Equity Mix 1. Divido Corporation is an all-equity financed firm with a total market value of $100 million.
Chapter 16 Debt-Equity Mix 1. Divido Corporation is an all-equity financed firm with a total market value of $100 million. The company holds $10 million in cash-equivalents and has $90 million in other
More informationA Basic Introduction to the Methodology Used to Determine a Discount Rate
A Basic Introduction to the Methodology Used to Determine a Discount Rate By Dubravka Tosic, Ph.D. The term discount rate is one of the most fundamental, widely used terms in finance and economics. Whether
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 "right-hand side" of the
More informationINTERVIEWS - FINANCIAL MODELING
420 W. 118th Street, Room 420 New York, NY 10027 P: 212-854-4613 F: 212-854-6190 www.sipa.columbia.edu/ocs INTERVIEWS - FINANCIAL MODELING Basic valuation concepts are among the most popular technical
More informationFinance 2 for IBA (30J201) F. Feriozzi Re-sit exam June 18 th, 2012. Part One: Multiple-Choice Questions (45 points)
Finance 2 for IBA (30J201) F. Feriozzi Re-sit exam June 18 th, 2012 Part One: Multiple-Choice Questions (45 points) Question 1 Assume that capital markets are perfect. Which of the following statements
More informationChapter 5 Financial Forwards and Futures
Chapter 5 Financial Forwards and Futures Question 5.1. Four different ways to sell a share of stock that has a price S(0) at time 0. Question 5.2. Description Get Paid at Lose Ownership of Receive Payment
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 high-risk projects, which usually have higher IRR due to their high-risk nature, and
More informationExpected default frequency
KM Model Expected default frequency Expected default frequency (EDF) is a forward-looking measure of actual probability of default. EDF is firm specific. KM model is based on the structural approach to
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 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 informationCHAPTER 22: FUTURES MARKETS
CHAPTER 22: FUTURES MARKETS PROBLEM SETS 1. There is little hedging or speculative demand for cement futures, since cement prices are fairly stable and predictable. The trading activity necessary to support
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 informationEstimating Beta. Aswath Damodaran
Estimating Beta The standard procedure for estimating betas is to regress stock returns (R j ) against market returns (R m ) - R j = a + b R m where a is the intercept and b is the slope of the regression.
More informationChapter 11, Risk and Return
Chapter 11, Risk and Return 1. A portfolio is. A) a group of assets, such as stocks and bonds, held as a collective unit by an investor B) the expected return on a risky asset C) the expected return on
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 informationCLASS NOTES ON CORPORATE FINANCE. Copyright 1999 by Yossi Spiegel
Preliminary and highly incomplete CLASS NOTES ON CORPORATE FINANCE by Yossi Spiegel * Berglas School of Economics, Tel Aviv University Spring 1999 Copyright 1999 by Yossi Spiegel * Parts of these class
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 informationFinancial Statement and Cash Flow Analysis
Chapter 2 Financial Statement and Cash Flow Analysis Answers to Concept Review Questions 1. What role do the FASB and SEC play with regard to GAAP? The FASB is a nongovernmental, professional standards
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 informationChapter 9 The Cost of Capital ANSWERS TO SELEECTED END-OF-CHAPTER QUESTIONS
Chapter 9 The Cost of Capital ANSWERS TO SELEECTED END-OF-CHAPTER QUESTIONS 9-1 a. The weighted average cost of capital, WACC, is the weighted average of the after-tax component costs of capital -debt,
More informationDiscount Rates and Tax
Discount Rates and Tax Ian A Cooper and Kjell G Nyborg London Business School First version: March 1998 This version: August 2004 Abstract This note summarises the relationships between values, rates of
More informationANSWERS TO END-OF-CHAPTER PROBLEMS WITHOUT ASTERISKS
Part III Answers to End-of-Chapter Problems 97 CHAPTER 1 ANSWERS TO END-OF-CHAPTER PROBLEMS WITHOUT ASTERISKS Why Study Money, Banking, and Financial Markets? 7. The basic activity of banks is to accept
More informationSwaps: Debt-equity swap
Swaps: Debt-equity swap INTRODUCTION Debt-equity (respectively equity-debt) swap allows a company, government, or municipality to swap debt for equity (respectively equity for debt). Debt and equity are
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 information140 SU 3: Profitability Analysis and Analytical Issues
140 SU 3: Profitability Analysis and Analytical Issues QUESTIONS 3.1 Profitability Ratios Questions 1 and 2 are based on the following information. The financial statements for Dividendosaurus, Inc., for
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 informationChapter 7. . 1. component of the convertible can be estimated as 1100-796.15 = 303.85.
Chapter 7 7-1 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 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 informationRISKS IN MUTUAL FUND INVESTMENTS
RISKS IN MUTUAL FUND INVESTMENTS Classification of Investors Investors can be classified based on their Risk Tolerance Levels : Low Risk Tolerance Moderate Risk Tolerance High Risk Tolerance Fund Classification
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 informationAPractitionersToolkitonValuation
APractitionersToolkitonValuation Part I: (Un)Levering the Cost of Equity and Financing Policy with Constant Expected Free Cash Flows: APV, WACC and CFE Frans de Roon, Joy van der Veer 1 Introduction Valuation
More informationCost of Capital. Katharina Lewellen Finance Theory II April 9, 2003
Cost of Capital Katharina Lewellen Finance Theory II April 9, 2003 What Next? We want to value a project that is financed by both debt and equity Our approach: Calculate expected Free Cash Flows (FCFs)
More informationCHAPTER 3 LONG-TERM FINANCIAL PLANNING AND GROWTH
CHAPTER 3 LONG-TERM FINANCIAL PLANNING AND GROWTH Answers to Concepts Review and Critical Thinking Questions 5. The sustainable growth rate is greater than 20 percent, because at a 20 percent growth rate
More informationFundamentals Level Skills Module, Paper F9. Section B
Answers Fundamentals Level Skills Module, Paper F9 Financial Management September/December 2015 Answers Section B 1 (a) Market value of equity = 15,000,000 x 3 75 = $56,250,000 Market value of each irredeemable
More informationReview for Exam 3. Instructions: Please read carefully
Review for Exam 3 Instructions: Please read carefully The exam will have 25 multiple choice questions and 5 work problems. You are not responsible for any topics that are not covered in the lecture note
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 One-Year Investor Potential Cash Flows Dividend Sale of Stock Timeline for One-Year Investor Since the cash flows are
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 informationRatio Analysis 0.75. Fixed Assets Fixed Assets + Net Working Capital =0.75 Fixed Assets
Ratio Analysis CA Past Years Exam Answer Answer to Q.1: (Nov, 009) Fixed assets ` 18,00,000 Proprietor s funds ` 4,00,000 Note: 1 Ratio of fixed assets to proprietor s funds 0.75 Properietors Fund 0.75
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 informationWEB APPENDIX. Calculating Beta Coefficients. b Beta Rise Run Y 7.1 1 8.92 X 10.0 0.0 16.0 10.0 1.6
WEB APPENDIX 8A Calculating Beta Coefficients The CAPM is an ex ante model, which means that all of the variables represent before-thefact, expected values. In particular, the beta coefficient used in
More informationChapter 5 Risk and Return ANSWERS TO SELECTED END-OF-CHAPTER QUESTIONS
Chapter 5 Risk and Return ANSWERS TO SELECTED END-OF-CHAPTER QUESTIONS 5-1 a. Stand-alone risk is only a part of total risk and pertains to the risk an investor takes by holding only one asset. Risk is
More information