Ch 17 and 18 debt policy (exam 3)

Ch 17 and 18 debt policy (exam 3) - Does Debt...

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Does Debt Policy/Capital Structure Matter? Chapters 17 and 18
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Ch. 17 Topics Covered Financial Leverage in a Competitive Tax Free Environment Financial Risk and Expected Returns The Weighted Average Cost of Capital A Final Word on After Tax WACC
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M&M (Debt Policy Doesn’t Matter) Modigliani & Miller When there are no taxes and capital markets function well, it makes no difference whether the firm borrows or individual shareholders borrow. Therefore, the market value of a company does not depend on its capital structure.
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M&M (Debt Policy Doesn’t Matter) Assumptions By issuing 1 security rather than 2, company diminishes investor choice. This does not reduce value if: Investors do not need choice, OR There are sufficient alternative securities Capital structure does not affect cash flows e.g. .. No taxes No bankruptcy costs No effect on management incentives
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M&M (Debt Policy Doesn’t Matter) • V u must equal V L . Why?
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M&M (Debt Policy Doesn’t Matter) • V u must equal V L . Why? – If I own .01 of V u or V L , I get .01 of firm profit. – If I had to pay more for V u , I would choose to buy V L instead, which would drive up the price of V L until both had the same price – If I had to pay more for V L , I would choose to buy V u instead, which would drive up the price of V u until both had the same price This means in equilibrium, both must have the same price (market value)
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MM'S PROPOSITION I If capital markets are doing their job, firms cannot increase value by tinkering with capital structure.
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This note was uploaded on 12/10/2011 for the course FIN 302 taught by Professor Kellybrunarski during the Spring '11 term at Miami University.

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Ch 17 and 18 debt policy (exam 3) - Does Debt...

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