5 Financing and Valuation

5 Financing and Valuation - Financing and Valuation Some...

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FIN 819: lecture 6 Financing and Valuation Some basic things in valuations
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FIN 819: lecture 6 Today’s plan Review what we have learned in the last lecture The capital structure decision The capital structure without taxes MM’s proposition 1 MM’s proposition 2 The capital structure with taxes MM’s proposition 1 MM’s proposition 2
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FIN 819: lecture 6 Today’s plan (Continue) The impact of financing on the cost of capital and equity Two approaches to calculate NPV WACC ( weighted average cost of capital approach) APV (adjusted present value approach)
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FIN 819: lecture 6 What have we learned in the last lecture In the last lecture, we have discussed the case in the end of chapter 12, what have you learned from this case? In the last lecture, we have also discussed three forms of market efficiency, what are they and what is your understanding of these three forms of market efficiency?
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FIN 819: lecture 6 Look at the both sides of a balance sheet Asset Liabilities and equity Market value of the asset V Market value of equity E Market value of debt D V=E+D
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FIN 819: lecture 6 Capital structure Capital structure refers to the mix of debt and equity in a firm. We often use D/E or D/V (V=D+E) to indicate the capital structure of a firm. Usually, the higher the ratio, the more debt a firm has The capital structure problem for a firm is to determine what is the maximum amount of debt a firm should have to maximize the firm’s value.
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FIN 819: lecture 6 Does capital structure affect the firm value? Equity Debt Equity Equity Debt Debt Govt. Govt. Slicing the pie doesn’t affect the total amount available to debt holders and equity holders Slicing the pie can affect the size of the slice going to government Slicing the pie can affect the size of the wasted slice wasted
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FIN 819: lecture 6 MM’s proposition 1 If the investment opportunity is fixed, there are no taxes, and capital markets function well, the market value of a company does not depend on its capital structure Based on the above result, any amount of debt is optimal How can we understand this? The size of a pizza has nothing to do with how you slice it.
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FIN 819: lecture 6 MM’s proposition 2 If the investment opportunity is fixed, there are no taxes, and capital markets function well, the expected rate of return on the common stock of a levered firm increases in proportion to the debt-equity ratio (D/E), expressed in market values. The WACC is independent of how the firm is financed
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FIN 819: lecture 6 r D V r D r E WACC WACC without taxes in MM’s view
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FIN 819: lecture 6 Example - River Cruises - All Equity Financed 17.5% 12.5% 7.5% shares on Return 1.75 1.25 $.75 share per Earnings 175,000 125,000 $75,000 Income Operating Boom Expected
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5 Financing and Valuation - Financing and Valuation Some...

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