Lecture14b.ppt

Lecture14b.ppt - Lecture14:Corporate Taxation,Part2...

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    Lecture 14:  Corporate  Taxation, Part 2
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    Outline of lecture Taxes and debt finance Taxes and investment Taxes and risk taking Taxation of multinationals
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    Corporate financial decisions Alternative sources of finance Borrow from banks or outside investors Issue equity to outside investors
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    What is Debt Finance? Debt finance is the raising of funds by borrowing from lenders, such as banks. It is often done by selling corporate bonds. Bonds are promises by a corporation to make periodic interest payments, as well as ultimate repayment of principal, to the bondholders (the lenders).
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    What is Equity Finance? Equity finance is the raising of funds by sale of ownership shares in a firm. Investors who buy shares in the company receive income in two different ways – dividends or capital gains. A dividend is a period payment investors receive from the company per share owned. A capital gain is the increase in the price of a share since its purchase.
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    Which source of finance is better,  ignoring taxes? Modigliani – Miller theorem Outside owners collectively receive the underlying profits earned by the firm, regardless of what the financing is called Ignoring real bankruptcy costs, form of finance is therefore irrelevant
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    Taxes and corporate finance  Miller – Modigliani correction: Taxes favor debt finance Logic: If firm borrows $1 from shareholders rather than issuing shares worth $1 Firm saves in taxes Shareholders pay in extra taxes Joint tax savings equal , which is positive whenever Remember that shareholders likely will lend through their pension plans, in which case r τ tr ( ) t r τ- t 0 t
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    Taxes vs. bankruptcy costs model Bankruptcy risk – firm goes bankrupt if it can’t pay interest but not if it can’t pay dividends Bankruptcy creates real costs Lawyers fees Disruption of business Anticipation of possible bankruptcy creates conflict of interest between debt and equity
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    Implications of conflict of interest Equity owners tempted to borrow and pay out funds as dividends Bonds typically include a covenant restricting dividend payments
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    Equity owners face incentive to undertake too risky investments If investment does well, equity gets all of the benefits If the investment does badly enough, bond
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Lecture14b.ppt - Lecture14:Corporate Taxation,Part2...

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