C09.+Chap+16.+Capital+Structure+-+Basic+Concepts.ppt

C09.+Chap+16.+Capital+Structure+-+Basic+Concepts.ppt -...

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Unformatted text preview: Chapter 16: Capital Structure Some Basic Concepts The Capital-Structure Question and The Pie Theory Maximizing Firm Value versus Maximizing Stockholder Interests Financial Leverage and Firm Value: An Example Modigliani and Miller: Proposition II (No Taxes) Taxes Summary and Conclusions 16.1 The Capital-Structure Question and The Pie Theory The value of a firm is defined to be the sum of the value of the firms debt and the firms equity. V = B + S If the goal of the management of the firm is to make the firm as valuable as possible, then the firm should pick the debt-equity ratio that makes the pie as big as possible. Value of the Firm S B S B S B 16.2 The Capital-Structure Question There are really two important questions: 1. Why should the stockholders care about maximizing firm value? Perhaps they should be interested in strategies that maximize shareholder value. 2. What is the ratio of debt-to-equity that maximizes the shareholders value? As it turns out, changes in capital structure benefit the stockholders if and only if the value of the firm increases. 16.3 Financial Leverage, EPS, and ROE Current Assets $20,000 Debt $0 Equity $20,000 Debt/Equity ratio 0.00 Interest rate n/a Shares outstanding 400 Share price $50 Proposed $20,000 $8,000 $12,000 2/3 8% 240 $50 Consider an all-equity firm that is considering going into debt. (Maybe some of the original shareholders want to cash out.) 16.4 EPS and ROE Under Current Capital Structure Recession Expected Expansion EBIT $1,000 $2,000 $3,000 Interest Net income $1,000 $2,000 $3,000 EPS $2.50 $5.00 $7.50 ROA 5% 10% 15% ROE 5% 10% 15% Current Shares Outstanding = 400 shares 16.5 EPS and ROE Under Proposed Capital Structure Recession Expected Expansion EBIT $1,000 $2,000 $3,000 Interest 640 640 640 Net income $360 $1,360 $2,360 EPS $1.50 $5.67 $9.83 ROA 5% 10% 15% ROE 3% 11% 20% Proposed Shares Outstanding = 240 shares 16.6 EPS and ROE Under Both Capital Structures All-Equity Recession Expected Expansion EBIT $1,000 $2,000 $3,000 Interest Net income $1,000 $2,000 $3,000 EPS $2.50 $5.00 $7.50 ROA 5% 10% 15% ROE 5% 10% 15% Current Shares Outstanding = 400 shares Levered Recession Expected Expansion...
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C09.+Chap+16.+Capital+Structure+-+Basic+Concepts.ppt -...

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