Chapter 16 App

Chapter 16 App - Chapter 16 Appendix 16A Capital Structure...

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Chapter 16 Capital Structure 16A-1 Some Useful Formulas of Financial Structure De± nitions: E(EBIT) 5 A perpetual expectation of cash operating income before interest and taxes. V U 5 Value of an unlevered ± rm. V L 5 Value of levered ± rm. B 5 Present value of debt. S 5 Present value of equity. R S 5 Cost of equity. R B 5 Cost of debt capital. R 0 5 Cost of capital to an all-equity ± rm. In a world of no corporate taxes, the weighted average cost of capital to a levered ± rm, R WAC C , is also equal to R 0 . However, with corporate taxes, R 0 is above R WACC for a levered ± rm. Model I (No Tax): V L 5 V U 5 E(EBIT) ________ R 0 R S 5 R 0 1 ( R 0 2 R B ) 3 B y S Model II (Corporate Tax, t C . 0; No Personal Taxes, t S 5 t B 5 0): V L 5 E[EBIT] 3 (1 2 t C ) _________________ R 0 1 t C R B B ______ R B 5 V U 1 t C B R S 5 R 0 1 (1 2 t C ) 3 ( R 0 2 R B ) 3 B y S Model III (Corporate Tax, t C . 0; Personal Tax, t B . 0; t S . 0): V L 5 V U 1 f 1 2 (1 2 t C ) 3 (1 2 t S ) ________________ (1 2 t B ) g 3 B The Miller Model and the Graduated Income Tax In Section 16.9, we assumed a ² at personal income tax on interest income. In other words, we assumed that all individuals are subject to the same personal tax rate on interest income. Merton Miller derived the results of this section in a classic paper. 1 However, the genius of his paper was to consider the implications of personal taxes when tax rates differ across individuals. This graduated income tax is consistent with the real world. For example, individuals are currently taxed at rates from 0 to 35 percent in the United States, depending on income. In addition, other entities, such as corporate pension funds, individual retirement accounts (IRAs), and universities, are tax exempt. Appendix 16A Appendix 16B 1 M. Miller, “Debt and Taxes,” Journal of Finance (May 1977). Yes, this is the same Miller of MM.
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16A-2 Part IV Capital Structure and Dividend Policy To illustrate Miller’s model with graduated taxes, we consider a world where all f rms initially only issue equity. We assume that t C 5 35 percent and t S 5 0. 2
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This note was uploaded on 01/17/2011 for the course ACTSC 372 taught by Professor Maryhardy during the Spring '09 term at Waterloo.

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Chapter 16 App - Chapter 16 Appendix 16A Capital Structure...

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