Chap014(WW-FIN357TAlt)SPR07

Chap014(WW-FIN357TAlt)SPR07 - 14-1Chapter Outline14.1 The...

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Unformatted text preview: 14-1Chapter Outline14.1 The Capital-Structure Question and The Pie Theory14.2 Maximizing Firm Value versus Maximizing Stockholder Interests14.3 Financial Leverage and Firm Value: An Example14.4 Modigliani and Miller Assumptions14.5 Modigliani and Miller (No Taxes)14.6 Modigliani and Miller (Corporate Taxes)14.7 Summary and Conclusions14-214.1 The Capital-Structure Question and The Pie TheoryThe value of a firm is defined as the sum of the value of the firms debt and the firms equity.V =B + SIf the goal of the firm is to maximize value, management should choose the debt-equity ratio that makes the pie as big as possible. Value of the FirmSBSBSBSB14-314.2 The Capital-Structure QuestionTwo important questions:1.Why should stockholders care about maximizing firmvalue when the goal of finance is to maximize shareholdervalue?.2.What is the ratio of debt-to-equity (or debt-to-capital) that maximizes shareholder value?Changes in capital structure benefit stockholders if and only ifthe value of the firm increases.14-414.3 Financial Leverage, EPS, and ROECurrentAssets$20,000Debt$0Equity$20,000Debt/Equity ratio0.00Interest raten/aShares outstanding400Share price$50Proposed$20,000$8,000$12,0002/38%240$50Consider an all-equity firm that is considering the use of debt financing. 14-5EPS and ROE Under CurrentCapital StructureRecessionExpectedExpansionEBIT$1,000$2,000$3,000InterestNet income$1,000$2,000$3,000EPS$2.50$5.00$7.50BEP = ROA5%10%15%ROE5%10%15%BEP = EBIT/Total AssetsCurrent Shares Outstanding = 400 shares14-6EPS and ROE Under ProposedCapital StructureRecessionExpectedExpansionEBIT$1,000$2,000$3,000Interest640640640Net income$360$1,360$2,360EPS$1.50$5.67$9.83BEP5%10%15%ROE3%11%20%Proposed Shares Outstanding = 240 shares14-7Financial Leverage and EPS(2.00)0.002.004.006.008.0010.0012.001,0002,0003,000EPSDebtNo DebtBreak-even point EBI in dollars, no taxesAdvantage to debtDisadvantage to debtEBIT14-814.4 Assumptions of the MM ModelsHomogeneous ExpectationsHomogeneous Business Risk ClassesPerpetual Cash FlowsPerfect Capital Markets:Perfect competitionFirms and investors can borrow/lend at the same rateEqual access to all relevant informationNo transaction costsNo taxes14-9Homemade Leverage: An ExampleRecessionExpectedExpansionEPS of Unlevered Firm$2.50$5.00$7.50Earnings for 40 shares$100$200$300Less interest on $800 (8%)$64$64...
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Chap014(WW-FIN357TAlt)SPR07 - 14-1Chapter Outline14.1 The...

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