lecture2 - Page 1 of 4 Help Week 2: Firm Valuation &...

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Introduction | Capital Structure Decision | Business and Financial Risk | Modigliani and Miller Models | The Miller Model | The Hamada Equation As we know, the job of the manager consists of evaluating the effects of alternative strategies on his or her firm's values by forecasting financial statements under different strategies, finding the present value of each strategy's cash flow streams, and then choosing the optimal strategy that maximizes the value. Company valuation will take on much more importance when you take the business planning seminar. In that course, you will be required to value the business you have started after 5 years of operation. This is to provide an exit from the firm for the investors that you took on when the firm was started; they do not want to remain investors forever, so they must be bought out. Thus, the need for the valuation. In the real world, valuation is continuously used in mergers/acquisitions (M/A), subsidiary and division formations and sales, and product line acquisitions and sales. Chapter 15 introduces one of the most important elements of managerial finance: the capital structure of the firm. Capital structure is defined as the mix of a firm's debt and equity financing. We will simplify this definition by eliminating short-term debt and consider only the firm's long-term debt as it relates to its equity. One of the perplexing issues facing financial managers is the relationship between the firm's capital structure and its current stock price. The question of how capital structure affects stock prices and cost of capital is far reaching and leads to other questions, such as the following: 1. Should different industries, and different firms within the same industry, have different capital structures? 2. What factors lead to these differences? One factor is the risk of the firm. In FI515, you learned that market risk is measured by the firm's beta, while stand-alone risk includes both market risk and company-specific risk. You recall that company-specific risk can be largely eliminated by diversification. However, part of a firm's stand-alone risk is its business risk – the uncertainty inherent
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This note was uploaded on 08/27/2011 for the course FI516 FI516 taught by Professor Fi516 during the Spring '11 term at Keller Graduate School of Management.

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lecture2 - Page 1 of 4 Help Week 2: Firm Valuation &...

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