Ch15 - k sL = 14 2.33 = 16.33 WACC(levered firm =(D/V)k...

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CHAPTER 15 Capital Structure Decisions:Part II
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B. B. Proposition I. 1. The weighted average cost of capital is independent of the firm's capital structure. 2. The WACC of a firm with debt is equal to the unlevered cost of equity. V = $500,000/0.14 = $ 3,571,429 for both firms Without Taxes 0% 5% 10% 15% 20% 25% 0% 20% 40% 60% Debt/Value Ratio Cost of Capital ks WACC kd
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B. B. (continued) Proposition II. The cost of equity : k sL = k sU + Risk premium = k sU + (k sU -k d )(D/S) k sl = 14 % +6%*0,39=16,33% WACC = (S/V)*k s + (D/V)*k d = 11.76% +2.24%=14% Modigliani and Miller with CorporateTaxes Proposition I Value of levered firm is the unlevered value plus the debt tax shield: V L = V U + TD Proposition II The cost of equity to a levered firm is the unlevered cost of equity plus a risk premium: k sL = k sU + (k sU - k d )(1-T)(D/S)
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C. C. Vu=500,000 (0.6)/0.14 = $2,142,857 Vl= $2,142,857 +0.4 ($1,000,000) = $ 2,542,857
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Unformatted text preview: k sL = 14 % +2.33% = 16.33% WACC (levered firm) = (D/V)k d (1-T) + (S/V)k s = 1.89% +9.91% =11.8% With Taxes 0% 5% 10% 15% 20% 25% 0% 20% 40% 60% 80% 100% Debt/Value Ratio Cost of Capital ks WACC kd x (1-T) D. D. The Miller Model The added value to the firm from using $D in debt is 0.25D. I.e. the total firm value increases by about 25% of the amount of debt used. If only corporate taxes were considered, then the leverage would be 40%. The Miller model, however, ignores agency costs, as well as costs associated with bankruptcy, and hence, understates the true risk-adjusted required rates of return. C s U sU EBIT(1 T )(1 T ) V k- -= C s L U d (1 T )(1 T ) V V 1 D (1-T ) - -= + -...
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Ch15 - k sL = 14 2.33 = 16.33 WACC(levered firm =(D/V)k...

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