7/21/2019 Mid Sem Notes FINA2222

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14.1  Market Value of Equity = Market Value of Assets – Market value of Debt & other Liabilities

14.2  MMI  In a perfect capital market, the total value of a firm is equal to the market value of the total cash

flows generated by its assets & is not affected by its choice of capital structure.  

14.3  Pre-tax WACC

 

14.4  MMII The cost of capital of levered equity increases with the firm’s market value debt-equity ratio.

Cost of Capital of Levered Equity 

 

14.7 In perfect capital markets, a firm’s WACC is independent of its capital structure & is equal to its equity cost

of capital if it is unlevered, which matches the cost of capital of its assets.      

14.8

 

 

NB 1 A firm’s net debt is equal to its debt less its holdings of cash & other risk-free securities

15.2           As long as t* > 0

15.3  

   ITS with permanent debt, constant marginal tax rate no personal taxes

15.5 After-tax WACC

 

15.7  Effective Tax Advantage of Debt

 

15.9 Tax disadvantage for excess interest payments tc= 0

 

NB 2 Optimal level of leverage from a tax-saving perspective is the level such that interest equals EBIT 

NB 3 Optimal fraction of debt, as a proportional of a firm’s capital structure, declines with growth rate of firm 

16.1 Trade-off Theory      

16.2 Debt Overhang, shareholders prefer not to invest in positive NPV projects.

Equity holders only benefit when

 

16.3 Agency Costs + Trade-off Theory

     

 

NB 4 Bankruptcy. Direct firm & creditor: legal, accounting, auctioneers, appraisers, investment bankers. Indirect:

loss of customer, supplier, employees, receivables, fire sale assets, cost to creditors, inefficient liquidation.

NB 5 When securities are fairly priced, original shareholders of a firm pay the PV of costs associated with B & FD

NB 6 Agency Costs: Asset substitution, making riskier -NPV investments, Debt Overhang, Cashing Out for dividend

NB 7 Agency Benefits: Ownership Concentration, Reduced FCF, - managerial entrenchment and + commitment 

NB 8 Leverage may be used as credible signal to investors of a firm’s ability to generate future FCF

NB Managers are more likely to sell equity when they know a firm is overvalued, pecking order hypothesis. 

NB  where rm is expected market return