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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
2-3 Choice 2: D=\$8,000 Failure Expected Big Success EBIT \$1,000

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