Chapter 14
Capital Structure in a Perfect Market
14-1.
a.
EC1
()
±
²
³
´
=
1
2
130,000
+
180,000
=
155,000,
NPV
=
155,000
1.20
µ
100,000
=
129,167
µ
100,000
=
$29,167
b.
Equity value
=
PV C 1
=
155,000
1.20
=
129,167
c. Debt payments
=
100,000,
equity receives 20,000 or 70,000.
Initial value, by MM, is
129,167
±
100,000
=
$29,167
.
14-2.
a.
Total value of equity
=
2
±
$2m
=
$4m
b.
MM says total value of firm is still $4 million.
$1 million of debt implies total value of equity is $3 million.
Therefore, 33% of equity must be sold to raise $1 million.
c.
In (a), 50%
±
$4M = $2M.
In (b), 2/3
±
$3M = $2M.
Thus, in a perfect market the choice of capital
structure does not affect the value to the entrepreneur.
14-3.
a.
E[Value in one year]
=
0.8 50
+
0.2 20
=
44
.
E
=
44
1.10
=
$40m
.
b. D =
20
1.05
=
19.048
.
Therefore,
E
=
40
±
19.048
=
$20.952m
.
c. Without leverage, r=
44
40
±
1
=
10%
, with leverage, r=
44
±
20
20.952
±
1
=
14.55%
.
d.
Without leverage,
r=
20
40
±
1
=
±
50%
,
with leverage, r=
0
20.952
±
1
=
±
100%
.
14-4.
a.
ABC
XYZ
FCF
Debt
Payments
Equity
Dividends
Debt
Payments
Equity
Dividends
$800
0
800
500
300
$1,000
0
1000
500
500