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1、Capital Structure: Basic Concepts,Chapter 16,Copyright 2010 by the McGraw-Hill Companies, Inc. All rights reserved.,McGraw-Hill/Irwin,Key Concepts and Skills,Understand the effect of financial leverage (i.e., capital structure) on firm earnings Understand homemade leverage Understand capital structu
2、re theories with and without taxes Be able to compute the value of the unlevered and levered firm,Chapter Outline,16.1 The Capital Structure Question and The Pie Theory 16.2 Maximizing Firm Value versus Maximizing Stockholder Interests 16.3 Financial Leverage and Firm Value: An Example 16.4 Modiglia
3、ni and Miller: Proposition II (No Taxes) 16.5 Taxes,16.1 Capital Structure and the Pie,The value of a firm is defined to be the sum of the value of the firms debt and the firms equity. V = B + S,If the goal of the firms management is to make the firm as valuable as possible, then the firm should pic
4、k the debt-equity ratio that makes the pie as big as possible.,Value of the Firm,S,B,S,B,Stockholder Interests,There are two important questions: Why should the stockholders care about maximizing firm value? Perhaps they should be interested in strategies that maximize shareholder value. What is the
5、 ratio of debt-to-equity that maximizes the shareholders value? As it turns out, changes in capital structure benefit the stockholders if and only if the value of the firm increases.,16.3 Financial Leverage, EPS, and ROE,Current Assets$20,000 Debt$0 Equity$20,000 Debt/Equity ratio0.00 Interest raten
6、/a Shares outstanding400 Share price$50,Proposed $20,000 $8,000 $12,000 2/3 8% 240 $50,Consider an all-equity firm that is contemplating going into debt. (Maybe some of the original shareholders want to cash out.),EPS and ROE Under Current Structure,RecessionExpected Expansion EBIT$1,000$2,000$3,000
7、 Interest000 Net income$1,000$2,000$3,000 EPS$2.50$5.00$7.50 ROA5%10%15% ROE5%10%15% Current Shares Outstanding = 400 shares,EPS and ROE Under Proposed Structure,RecessionExpected Expansion EBIT$1,000$2,000$3,000 Interest640640640 Net income$360$1,360$2,360 EPS$1.50$5.67$9.83 ROA1.8%6.8%11.8% ROE3.0
8、%11.3%19.7% Proposed Shares Outstanding = 240 shares,Financial Leverage and EPS,(2.00),0.00,2.00,4.00,6.00,8.00,10.00,12.00,1,000,2,000,3,000,EPS,Debt,No Debt,Break-even point,EBIT in dollars, no taxes,Advantage to debt,Disadvantage to debt,Assumptions of the M&M Model,Homogeneous Expectations Homog
9、eneous Business Risk Classes Perpetual Cash Flows Perfect Capital Markets: Perfect competition Firms and investors can borrow/lend at the same rate Equal access to all relevant information No transaction costs No taxes,Homemade Leverage: An Example,RecessionExpected Expansion EPS of Unlevered Firm$2
10、.50$5.00$7.50 Earnings for 40 shares$100$200$300 Less interest on $800 (8%)$64$64$64 Net Profits$36$136$236 ROE (Net Profits / $1,200)3.0%11.3%19.7% We are buying 40 shares of a $50 stock, using $800 in margin. We get the same ROE as if we bought into a levered firm. Our personal debt-equity ratio i
11、s:,Homemade (Un)Leverage: An Example,RecessionExpected Expansion EPS of Levered Firm$1.50$5.67$9.83 Earnings for 24 shares$36$136$236 Plus interest on $800 (8%)$64$64$64 Net Profits$100$200$300 ROE (Net Profits / $2,000)5%10%15% Buying 24 shares of an otherwise identical levered firm along with some
12、 of the firms debt gets us to the ROE of the unlevered firm. This is the fundamental insight of M&M,MM Proposition I (No Taxes),We can create a levered or unlevered position by adjusting the trading in our own account. This homemade leverage suggests that capital structure is irrelevant in determini
13、ng the value of the firm: VL = VU,16.4 MM Proposition II (No Taxes),Proposition II Leverage increases the risk and return to stockholders Rs = R0 + (B / SL) (R0 - RB) RB is the interest rate (cost of debt) Rs is the return on (levered) equity (cost of equity) R0 is the return on unlevered equity (co
14、st of capital) B is the value of debt SL is the value of levered equity,MM Proposition II (No Taxes),The derivation is straightforward:,MM Proposition II (No Taxes),Debt-to-equity Ratio,Cost of capital: R (%),R0,RB,RB,16.5 MM Propositions I & II (With Taxes),Proposition I (with Corporate Taxes) Firm
15、 value increases with leverage VL = VU + TC B Proposition II (with Corporate Taxes) Some of the increase in equity risk and return is offset by the interest tax shield RS = R0 + (B/S)(1-TC)(R0 - RB) RB is the interest rate (cost of debt) RS is the return on equity (cost of equity) R0 is the return o
16、n unlevered equity (cost of capital) B is the value of debt S is the value of levered equity,MM Proposition I (With Taxes),The present value of this stream of cash flows is VL,The present value of the first term is VU The present value of the second term is TCB,MM Proposition II (With Taxes),Start with M&M Proposition I with taxes:,Since,The cash flows from each side of the balance sheet must equal:,Divide both sides by S,Which quickly reduces to,The Effect
