lecture_11 - Introduction to Managerial Finance Lecture...

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Introduction to Managerial Finance Lecture Notes 11 Prof. H. Wang © copyright 1
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ACC and Beta WACC and Beta ± We have already seen how equity beta’s will change with leverage D E = D A E D E A E D E D E D E D β ) / ( ) / 1 ( + = + + + ± Consider an all-equity firm with an asset beta of 0.52 • All Equity => β E = β A t f C it l E it MCR • Cost of Capital = Equity MCR R E = R A = r f + 0.52 ( R Mkt r f ) = 5% + 0.52 (6%) = 8.12% 2
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± Suppose the firm instead issues riskless debt at the 5% rate, with a D/E ratio of 0.5 ) / ( ) / 1 ( + = D A E E D E D β i t M C R 0.78 0.52 0.5) (1 = × + = • Equity MCR R E = 5% + 0.78 (6%) = 9.68% •WACC % 12 . 8 % 5 5 . 0 1 5 . 0 % 68 . 9 5 . 0 1 1 = + + + = WACC R 3
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everage and Taxes Leverage and Taxes ± So far, we have considered the effects of leverage in a “PERFECT” world • In such a world, leverage does not effect value, only risk and return • In this case, financing choices and capital structure are irrelevant e eva t • But in the real world, firms must pay taxes • Can leverage be used to reduce taxes, and increase value? 4
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± Interest payments on debt can be deducted from corporate earnings before paying corporate income tax: • Thus, paying interest (as opposed to dividends) is a way to give money back to investors without paying corporate income tax •T h ere is a “Tax Shield” associated with debt that is e e s a a S e d assoc ated w t debt t at s valuable! 5
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± Another View • Before: V(Firm) = V(Equity) + V(Debt) = V(Asset) • With Taxes: V(Firm) = V(Equity) + V(Debt) = V(Assets) – V(Taxes) ow do we maximize firm value? ± How do we maximize firm value? • Choose investment policy to maximize NPV hoose financial policy to minimize taxes 6 Choose financial policy to minimize taxes
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he Interest Tax Shield The Interest Tax Shield ± Debt reduces the government’s share of the corporate pie uppose the firm’s net income is 500 and corporate tax rate is 40% Suppose the firm s net income is 500 and corporate tax rate is 40%.
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This document was uploaded on 10/21/2010.

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lecture_11 - Introduction to Managerial Finance Lecture...

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