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finance-mt2-cheat-sheet (1).docx

finance-mt2-cheat-sheet (1).docx - Valuation equation V op=...

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Valuation equation V op = T = t FC F t ( 1 + WACC ) t , V op = T = t FC F t ( 1 + WACC ) t Effects of financial leverage; (1) Payment to creditors: fixed interest payment (2) Payment to shareholders: variable leftover payment after all the costs and expenses are paid… affects ROE of firm by (1) if the firm has a really good year, then it pays the fixed interests and has more leftover for the shareholders, (2) if the firm has a really bad year, it still has to pay the fixed interests and has less left over for the shareholders Corporate taxes If the firm is an ongoing entity, we can value the tax savings as a perpetuity using the perpetuity formula PV perpetuity = CF r , in the case of tax savings we show that CF = r d DT ; Therefore the PV of tax savings is PV taxsavings = r d DT r d = TD value of a levered firm is the value of an otherwise identical unlevered firm plus tax savings V L = V U + V tax savings the more a firm borrows, the higher the firm value PERPETUITY TAX SAVINGS ( MORETHAN 1 YEAR ) PV tax savings = CF r [ 1 1 ( 1 + r ) N ] …Corporate and personal taxes Net impact of corporate and personal taxes on firm value V L = V U + [ 1 ( 1 T c ) ( 1 T s ) 1 T d ] D … PV taxsavings = V L V U = [ 1 ( 1 T c ) ( 1 T s ) 1 T d ] D first calculate the annual tax savings to use of debt; then calculate the PV of those annual tax savings using a perpetuity… after tax annual cash flows to the firm’s shareholders (no debt) C F U = EBIT ( 1 T c ) ( 1 T s ) = ¿ ... with debt C F E = ( EBIT r d D ) ( 1 T c ) ( 1 T s ) + C F D = r d D ( 1 T d ) … PV of tax benefit PV= tax savings r d ( 1 T d ) Other capital structure theories Trade off theory; (1) tax deductibility of interest payments (2) Financial distress and agency costs… Pecking order theory (1) firms should raise funds first from internal sources, then by borrowing, and finally by issuing equity (2) reserve borrowing capacity Initial Public Offering (IPO) (1) selling some of a company’s stock to outside investors, and (2) letting the stock trade in public markets, turning the company from privately owned to publicly owned… Why do companies go public? some benefits/motivations include; (1) additional source of capital, (2) allowing funders to harvest their wealth, (3) stock prices give measure of performance, (4) allows managers to
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