Lecture_17_ - 2-1Lecture 17Capital Structure: Agency Cost...

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Unformatted text preview: 2-1Lecture 17Capital Structure: Agency Cost of Debt (Continue)2-2Agency CostAgency costs are included in the static model for the value of the firm:2-3Tax Effects and Financial DistressDebt (B)Value of firm (V)Value of firm underMM with corporatetaxes and debtV = Actual value of firmVU = Value of firm with no debtB*Maximumfirm valueOptimal amount of debtTax ShieldPV of Financial Distress and agency costs2-4Example of UnderinvestmentThe All-Mine Corporation is deciding whether to invest in a new project. The project would have to be financed by equity, the cost is $2,000 and will return $2,500 or 25% in one year. The discount rate for both bonds and stock is 15% and the tax rate is zero. The predicted cash flows from the firms existing assets are $4,500 in a good economy, $3,000 in an average economy and $1,000 in a poor economy. Each economic outcome is equally likely and the promised debt repayment is $3,000. Should the company take the project? What is the value of firm and its components before and after the project addition? 2-5...
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Lecture_17_ - 2-1Lecture 17Capital Structure: Agency Cost...

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