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Unformatted text preview: assist their argument Miller and Modigliani provides the following example:
Consider two firms, firm U and firm L, that generate the same cash flow
– Firm U is all equity financed (i.e. firm U is unlevered)
Firm L is financed by a mix of debt and equity (i.e. firm L is levered) Download free ebooks at bookboon.com
57 Corporate Finance Corporate ﬁnancing and valuation Letting D and E denote debt and equity, respectively, total value V is comprised by
- VU = EU
VL = DL + EL for the unlevered Firm U
for the levered Firm L Then, consider buying 1 percent of either firm U or 1 percent of L. Since Firm U is wholly equity financed
the investment of 1% of the value of U would return 1% of the profits. However, as Firm L is financed by
a mix of debt and equity, buying 1 percent of Firm L is equivalent to buying 1% of the debt and 1% of the
equity. The investment in debt returns 1% of the interest payment, whereas the 1% investment in equity
returns 1% of the profits after interest. The investment and returns are summarized in the following table. Return 1% of Firm U 1% · VU 1% · Profits 1% of Firm L
- 1% of debt
- 1% of equity 1% · DL
1% · EL 1% · Interest
1% · (Profits - Interest) = 1% (DL + EL) = 1% · VL Please click t...
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This note was uploaded on 10/26/2012 for the course 19 19 taught by Professor - during the Spring '12 term at Sunway University College.
- Spring '12