Lect 12 Fin 221 web

Lect 12 Fin 221 web - Managerial Finance Lecture 12 Capital...

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1 Managerial Finance Lecture 12 Capital Structure Private Equity Returns Assumptions: Two assets only: • Treasuries: risk free =4 percent • SP500: expected market risk premium (r m -r f )= 6 percent You have $1 to invest 1. How do you get… • A 4% percent expected return • A 10% percent expected return • A 16% percent expected return A 16% percent expected return • A 28% percent expected return 2. Do we create value by increasing our expected return from 4 to over 28 percent? • We increase risk • We do not increase value today 2
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2 The Capital Structure Question So far we tried to answer the following question: The next question: How should the firm raise the capita necessary to make Which projects should the firm invest in to maximize value ? Key tools: FCF, NPV, Beta & CAPM (security market line) capital necessary to make these investments? Should it: • Borrow ( issue debt )? • Sell shares ( issue equity )? 3 Assets Liabilities Projects & Investments undertaken by firm Securities issued by firm: (Take Positive NPV Projects) Debt Equity Capital structure in the news MF Global’s bankruptcy Broke broker An old hand on Wall Street is crushed by a bet on Europe Nov 5th 2011 (Excerpts) THE euro-zone crisis had already brought Dexia, a Franco-Belgian lender, low. This week it claimed its first American scalp. On October 31st, in the biggest collapse of a financial firm since that of Lehman Brothers in 2008, MF Global went bankrupt. It is too soon for a definitive autopsy on MF, but excessive leverage and proprietary 4 bets were clearly to blame. The largest of these was a leveraged punt on the bonds of peripheral euro-zone governments, notably Spain and Italy, exceeding $6 billion. In theory, these bets promised large profits at little risk: MF Global revealed the basic components of its European bet in May, prompting no evident concern in markets. Numerous lessons will be drawn from MF’s collapse. In its bankruptcy filing, it revealed that it had less than $1 billion in equity supporting more than $40 billion in assets, a staggering level of leverage in an era when financial firms were meant to be ratcheting down risk.
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3 What does “optimal capital structure” mean? A firm’s mix of alternative sources of capital is referred as its capital structure Debt *: bank debt, bonds. Equity : common, preferred, etc. Definition : optimal capital structure is the mix of securities (e.g., debt and equity) issued by the firm that maximize its value New mission statement : find the leverage ratio (debt to capital ratio) that maximizes value Understand what should not be emphasized in capital structure debates Enterprise value is: 2 FCF FCF FCF How can leverage change enterprise value?
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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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Lect 12 Fin 221 web - Managerial Finance Lecture 12 Capital...

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