11 11 18 Review Session 7 _Concept Review_

11 11 18 Review Session 7 _Concept Review_ - so they might...

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Managerial Finance: Review Session 7 TA: Pablo Villanueva November 18, 2011
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Agenda for Today 1. New Reasons why MM does not Hold Bankruptcy Costs (Financial Distress). Questions 16.8 and 16.12 Agency Costs of Leverage Excessive Risk Taking (Asset Substitution). Question 16.16 and 16.19 Debt Over Hang. Question 16.25. Agency Benefits of Leverage Assymetric Information Question 16.30
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Bankruptcy Costs 1. When firms go bankrupt, debtholders take over all the assets. However, this process has a cost that does not go to either equity or bond holders. This cost leaves the firm! 2. V L = V U + PV (Tax Shield) - PV (Financial Distress)
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Agency Cost of Leverage 1. Excessive Risk . Managers take excessive risk because they have limited liability in the downside! For them, it is the same that the value of the firm is equal to the value of debt or zero,
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Unformatted text preview: so they might as well take on projects with high upside. 2. Debt Overhang . If the rm faces nancial distress, each extra dollar of return goes to debt holders so managers will not carry on some positive present value projects since the benet goes to them. 3. Equity holders benet from new investment only if: NPV I > D D E E Agency Benets of Leverage 1. Leverage ties managers hands and it commits him/her to avoid wasteful investment. Assymetric Information 1. Only overvalued rms will raise equity. Managers who perceive the rms equity is underpriced will have a preference to fund investment using retained earnings, or debt, rather than equity....
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This note was uploaded on 01/08/2012 for the course MS&E 245G taught by Professor Perez-gonzalas during the Fall '11 term at Stanford.

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11 11 18 Review Session 7 _Concept Review_ - so they might...

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