FNCE 100 ch 15

FNCE 100 ch 15 - V=B+S 100 shares of stock each sell for...

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V = B + S 100 shares of stock each sell for $10 Market value of firm = 1000 Borrow 500 to pay proceeds to shareholders as a cash dividends (5 / share) After restructuring iBankers assess that equity will not change more than 250 in either direction. No Debt I II III Debt 0 500 500 500 Equity 1000 750 500 250 Firm Val 1000 1250 1000 750 Dividend represents partial liquidation of the firm Thus, less value in the firm after dividend is paid Also stockholders are paid after bondholders up liquidation Thus, Value decreases IF outcome I is most likely they should definitely restructure Changes in capital structure benefit holders if value of firm increases Now to determine optimal capital structure: All equity firm Assets = 8000 Outstanding shares = 400 Price / share = 20 iRate = .10 Proposal: Issue 4000 worth of debt to buy back equity This leaves 4000 in equity Prop I: Investors will make homemade leverage thus structure irrelevant Prop II: Required Return to Equity holders Leverage has greater risk, thus expected return increases (rB) rb = interest rate = cost of debt rs = expected return on stock or equity (cost of equity ) rwacc is the firm’s weighted average cost of capial B = value of the firm’s debt or bonds S = value of the firm’s stock or equity Rwacc is same form levered and unlevered firm Rwacc = B / (B + S) x rb + S / (B + S) x rs r0 = cost of capital for an all equity firm = Expected earnings to unlevered firm / unlevered equity r0 = rwacc in a world without taxes rs = r0 + B/S(r0-rB) rs(cost of equity) increases with debt r0 > bB because unlevered equity is risky v. riskless debt Difference between rs and r0 ?As debt / equity ratio increases Every dollar of equity is levered with additional debt This raises the risk of equity and therefore the required return (rs) Note r0 is only one point…all equity firm Earnings = 10M in perpetuity All earnings paid as dividends Shares outstanding = 10MM
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This note was uploaded on 10/06/2010 for the course FNCE 100 taught by Professor Jaffe during the Spring '10 term at UNC Asheville.

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