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1、Chapter 16Financial Leverage and Capital Structure Policy1完整版ppt2021/11/22Chapter Outline The Capital Structure Question The Effect of Financial Leverage Capital Structure and the Cost of Equity Capital M&M Propositions I and II with Corporate Taxes Bankruptcy Costs Optimal Capital Structure The Pie
2、 Again The Pecking-Order Theory Observed Capital Structures A Quick Look at the Bankruptcy Process16-22完整版ppt2021/11/22Capital Restructuring We are going to look at how changes in capital structure affect the value of the firm, all else equal Capital restructuring involves changing the amount of lev
3、erage a firm has without changing the firms assets The firm can increase leverage by issuing debt and repurchasing outstanding shares The firm can decrease leverage by issuing new shares and retiring outstanding debt16-33完整版ppt2021/11/22Choosing a Capital Structure What is the primary goal of financ
4、ial managers? Maximize stockholder wealth We want to choose the capital structure that will maximize stockholder wealth We can maximize stockholder wealth by maximizing the value of the firm or minimizing the WACC16-44完整版ppt2021/11/22The Effect of Leverage How does leverage affect the EPS and ROE of
5、 a firm? When we increase the amount of debt financing, we increase the fixed interest expense If we have a really good year, then we pay our fixed cost and we have more left over for our stockholders If we have a really bad year, we still have to pay our fixed costs and we have less left over for o
6、ur stockholders Leverage amplifies the variation in both EPS and ROE16-55完整版ppt2021/11/22Example: Financial Leverage, EPS and ROE Part I We will ignore the effect of taxes at this stage What happens to EPS and ROE when we issue debt and buy back shares of stock?16-66完整版ppt2021/11/22Example: Financia
7、l Leverage, EPS and ROE Part II Variability in ROE Current: ROE ranges from 6% to 20% Proposed: ROE ranges from 2% to 30% Variability in EPS Current: EPS ranges from $0.60 to $2.00 Proposed: EPS ranges from $0.20 to $3.00 The variability in both ROE and EPS increases when financial leverage is incre
8、ased16-77完整版ppt2021/11/22Break-Even EBIT Find EBIT where EPS is the same under both the current and proposed capital structures If we expect EBIT to be greater than the break-even point, then leverage may be beneficial to our stockholders If we expect EBIT to be less than the break-even point, then
9、leverage is detrimental to our stockholders16-88完整版ppt2021/11/22Example: Break-Even EBIT16-99完整版ppt2021/11/22Example: Homemade Leverage and ROECurrent Capital StructureInvestor borrows $500 and uses $500 of her own to buy 100 shares of stockPayoffs: Recession: 100(0.60) - .1(500) = $10 Expected: 100
10、(1.30) - .1(500) = $80 Expansion: 100(2.00) - .1(500) = $150Mirrors the payoffs from purchasing 50 shares of the firm under the proposed capital structureProposed Capital StructureInvestor buys $250 worth of stock (25 shares) and $250 worth of bonds paying 10%.Payoffs: Recession: 25(.20) + .1(250) =
11、 $30 Expected: 25(1.60) + .1(250) = $65 Expansion: 25(3.00) + .1(250) = $100Mirrors the payoffs from purchasing 50 shares under the current capital structure16-1010完整版ppt2021/11/22Capital Structure Theory Modigliani and Miller (M&M)Theory of Capital Structure Proposition I firm value Proposition II
12、WACC The value of the firm is determined by the cash flows to the firm and the risk of the assets Changing firm value Change the risk of the cash flows Change the cash flows16-1111完整版ppt2021/11/22Capital Structure Theory Under Three Special Cases Case I Assumptions No corporate or personal taxes No
13、bankruptcy costs Case II Assumptions Corporate taxes, but no personal taxes No bankruptcy costs Case III Assumptions Corporate taxes, but no personal taxes Bankruptcy costs16-1212完整版ppt2021/11/22Case I Propositions I and II Proposition I The value of the firm is NOT affected by changes in the capita
14、l structure The cash flows of the firm do not change; therefore, value doesnt change Proposition II The WACC of the firm is NOT affected by capital structure16-1313完整版ppt2021/11/22Case I - Equations WACC = RA = (E/V)RE + (D/V)RD RE = RA + (RA RD)(D/E) RA is the “cost” of the firms business risk, i.e
15、., the risk of the firms assets (RA RD)(D/E) is the “cost” of the firms financial risk, i.e., the additional return required by stockholders to compensate for the risk of leverage16-1414完整版ppt2021/11/22Figure 16.316-1515完整版ppt2021/11/22Case I - Example Data Required return on assets = 16%; cost of d
16、ebt = 10%; percent of debt = 45% What is the cost of equity? RE = 16 + (16 - 10)(.45/.55) = 20.91% Suppose instead that the cost of equity is 25%, what is the debt-to-equity ratio? 25 = 16 + (16 - 10)(D/E) D/E = (25 - 16) / (16 - 10) = 1.5 Based on this information, what is the percent of equity in the firm? E/V = 1 / 2.5 = 40%16-1616完整版ppt2021/11/22The CAPM, the SML and Proposition II How does financial leverage affect systematic risk? CAPM: RA = Rf + A(RM Rf) Where A is the firms asset beta an
