Example_for_Lecture_13

Example_for_Lecture_13 - Capital Restructuring and Firm...

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Unformatted text preview: 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) 2) 3) No debt and cost of Equity RE=10% Borrow $8,000 at 8%, and RE=12% Borrow $12,000 at 10%, and RE=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 2-1 Choice 1: D=0 EBIT Interest EBT Taxes (Tc = 35%) Total Cash Flow to S/H Cost of Debt Cost of Equity Equity Value = CF/RE Debt Value Failure $1,000 0 $1,000 $350 $650 NA 10% $6,500 NA $13,000 NA $19,500 NA Expected $2,000 0 $2,000 $700 $1,300 Big Success $3,000 0 $3,000 $1,050 $1,950 Expected Firm Value: $13,000 =$6,500 *1/3+$13,000 *1/3+$19,500 *1/3 2-2 Choice 2: D=$8,000 Failure EBIT $1,000 Interest ($8000 @ 8% ) $ 640 EBT $ 360 Taxes (Tc = 35%) $ 126 Cash Flow to Equity $ 234 Cost of Equity 12% Equity Value = CF/RE Debt Value Firm Value =D+E Expected Firm Value Expected Big Success $2,000 $3,000 $ 640 $ 640 $1,360 $2,360 $ 476 $ 826 $ 884 $1,534 $12,783 $8,000 $20,783 $1,950 $7,367 $8,000 $8,000 $9,950 $15,367 $15,367 2-3 Choice 3: D=$10,000 Failure Expected EBIT $1,000 $2,000 Interest ($12,000 @ 10% ) $ 1,200 $ 1,200 EBT ($200) $800 Taxes (Tc = 35%) ($70) $280 Cash Flow to Equity $0 (default) $520 Cost of Equity Equity Value = CF/RE Debt Value Firm Value =D+E 18% $0 $4000 $4000 Big Success $3,000 $ 1,200 $1,800 $630 $1,170 Expected Firm Value $12,463 $2,889 $12,000 $14,889 $6,500 $12,000 $18,500 2-4 Firm Value Firm Value L L U U 0 Debt-equity ratio, D/E Firm Value, V =15,367 2-5 ...
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This note was uploaded on 07/04/2011 for the course FINA 463 taught by Professor Tsyplakov during the Fall '10 term at South Carolina.

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Example_for_Lecture_13 - Capital Restructuring and Firm...

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