E firm u is unlevered firm l is financed by a mix of

Info iconThis preview shows page 1. Sign up to view the full content.

View Full Document Right Arrow Icon
This is the end of the preview. Sign up to access the rest of the document.

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...
View Full Document

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.

Ask a homework question - tutors are online