Lecture_5___Info_Asymm_Fall08

Lecture_5___Info_Asymm_Fall08 - Corporate Financial...

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Corporate Financial Policy (NBA 558) UST wrap-up Information Asymmetry and Financing Decisions Johnson Graduate School of  Management Fall 2008 Prof. Mark Leary
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2 Tax shields at UST Before the recapitalization: CF to equity: 499 CF to debt: 0 Total: 499 After the recapitalization: CF to equity: 459 CF to debt: 65 Total: 524 Difference = 524 – 499 = 25 = 65*38% Assume the $1 billion will remain outstanding perpetually How does a lender think about debt value (D)? D = PV[E(CF to debt)] = PV[E(interest)] How can the firm think about tax shield value? PV(TS) = PV[t c *E(interest)] = t c *PV[E(interest)] = t c *D
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3 UST – share price impact Before the recapitalization: P = 34.88 E = $6,471 N = 6,471 / 34.88 = 185.5 million shares D = $100 After the recapitalization: V = (6,471+100) + (0.38)*1,000 = 6,950.8 E = V – D = 6,950.8 – 1,100 = 5,850.8 nP = 1,000 (n = #shares repurchased) P = E/(185.5-n) 185.5P – nP = 5,850.8 P = (5,850.8 + 1,000) / 185.5 = $36.93
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4 UST – Summary Analyzing credit risk requires balancing a variety of factors Current cash flow (EBITDA) relative to expected debt service Expected future cash flow Business risks Ability to fund investment (after paying interest and taxes) Nature of assets (how much can we recover in default) Ignoring all market “frictions” V U = V L With tax deductible interest – V U = V L + PV(tax shields) If the debt is perpetual, V U = V L + t c *D Existing shareholders capture the tax shield value
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