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Example_for_Lecture_13

Example_for_Lecture_13 - Capital Restructuring and Firm...

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2-1 Capital Restructuring and Firm Value Firm’s Cash Flows in perpetuity will be Failure(prob=1/3) Expected(1/3) Big Success(1/3) $1,000 $2,000 $3,000 Consider 3 choices of cap structure for the firm: 1) No debt and cost of Equity R E =10% 2) Borrow $8,000 at 8%, and R E =12% 3) Borrow $12,000 at 10%, and R E =18% In case the firm defaults, the debtholders recover value of $4000 and equityholders get 0. Note: the debt maybe be sold at a discount to its par value
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2-2 Choice 1: D=0 Failure Expected Big Success EBIT $1,000 $2,000 $3,000 Interest 0 0 0 EBT $1,000 $2,000 $3,000 Taxes ( T c = 35%) $350 $700 $1,050 Total Cash Flow to S/H $650 $1,300 $1,950 Cost of Debt  NA Cost of Equity 10% Equity Value = CF/R E $6,500  $13,000  $19,500  Debt Value  NA NA NA Expected  Firm Value:          $13,000 = $6,500 *1/3+$13,000 *1/3+$19,500 *1/3
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2-3 Choice 2: D=$8,000 Failure Expected Big Success EBIT $1,000
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