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1、WACC and Debt PolicyOptimal Capital Structure?M&M (Debt Policy Doesnt Matter)Modigliani & Miller (Proposition I)When there are no taxes and capital markets are perfect, the market value of a company does not depend on its capital structure.The Value of the firm does not change with debt: VL = VURetu
2、rn on Assets (wacc)No TaxesNote: rA = WACC (with no taxes)M&M Proposition IIV = D + EThese should be Market values!The cost of equity capital increases with financial leverage due to the increase in Risk!rDErDrEM&M Proposition IIrA = WACCRisk free debtRisky debtLeverage and ReturnsImpact on BetaLeve
3、rage and ReturnsImpact on BetaIf the Beta of Debt is assumed to be Zero BD = 0The Beta of the Levered Firm is Equal to theBeta of the Unlevered Firm (or Asset Beta) timesOne plus the Debt-to-Equity RatioNote: Equity betas are levered betas and asset betas areunlevered betas (L=E and U=A).WACC (no ta
4、xes) WACC is the traditional view of capital structure, risk and return.Capital Structurewith taxesPV of Tax Shield = (assume perpetuity) D x rD x Tc rD= D x TcFirm Value = Value of All Equity Firm + PV Tax ShieldVL = VU + TC x DMM Proposition I with Corporate TaxesMM Prop. I with TaxesDebtMarket Va
5、lue of The FirmValue ofunleveredfirmPV of interesttax shieldsValue of levered firmOptimal amount of debtMM with Corporate TaxesMM Proposition II with Corporate Taxesr0 = the return on the all equity financed firm (the unleveredfirm or the return on the assets of the firm)Debt and TaxesImpact on Beta
6、If the Beta of Debt is assumed to be Zero BD = 0Remember, L is the equity beta for a firm with leverage, andU is the beta for the firm with NO debtrDVrDrEWACCMM with Taxes: WACCr0Financial DistressCosts of Financial Distress - Costs arising from bankruptcy or distorted business decisions before bank
7、ruptcy.Market Value =Value if all Equity Financed + PV Tax Shield - PV Costs of Financial DistressFinancial DistressDebtMarket Value of The FirmValue ofunleveredfirmPV of interesttax shieldsCosts offinancial distressValue of levered firmOptimal amount of debtMaximum value of firmWACC with TaxesImportant: The WACC FormulaWeighted Average Cost of Capital (with costs of financial distress)rDVrDrEWACCOptimal amount of debtCosts of DebtFinancial Distress CostsPersonal Tax Disadvantage of DebtAgency CostsInformation Costs (or Benefits) of DebtThe Pecking Order Theory
