1、Key Concepts and Skills Understand the effect of financial leverage on cash flows and the cost of equity Understand the impact of taxes and bankruptcy on capital structure choice Understand the basic components of the bankruptcy process16-1Chapter Outline The Capital Structure Question The Effect of
2、 Financial Leverage Capital Structure and the Cost of Equity Capital M&M Propositions I and II with Corporate Taxes Bankruptcy Costs Optimal Capital Structure The Pie Again The Pecking-Order Theory Observed Capital Structures A Quick Look at the Bankruptcy Process16-2Capital Restructuring We are goi
3、ng to look at how changes in capital structure affect the value of the firm,all else equal Capital restructuring involves changing the amount of leverage a firm has without changing the firms assets The firm can increase leverage by issuing debt and repurchasing outstanding shares The firm can decre
4、ase leverage by issuing new shares and retiring outstanding debt16-3Choosing a Capital Structure What is the primary goal of financial managers?Maximize stockholder wealth We want to choose the capital structure that will maximize stockholder wealth We can maximize stockholder wealth by maximizing t
5、he value of the firm or minimizing the WACC16-4The Effect of Leverage How does leverage affect the EPS and ROE of a firm?When we increase the amount of debt financing,we increase the fixed interest expense If we have a really good year,then we pay our fixed cost and we have more left over for our st
6、ockholders If we have a really bad year,we still have to pay our fixed costs and we have less left over for our stockholders Leverage amplifies the variation in both EPS and ROE16-5Example:Financial Leverage,EPS and ROE Part I We will ignore the effect of taxes at this stage What happens to EPS and
7、ROE when we issue debt and buy back shares of stock?16-6Example:Financial Leverage,EPS and ROE Part II Variability in ROE Current:ROE ranges from 6%to 20%Proposed:ROE ranges from 2%to 30%Variability in EPS Current:EPS ranges from$0.60 to$2.00 Proposed:EPS ranges from$0.20 to$3.00 The variability in
8、both ROE and EPS increases when financial leverage is increased16-7Break-Even EBIT Find EBIT where EPS is the same under both the current and proposed capital structures If we expect EBIT to be greater than the break-even point,then leverage may be beneficial to our stockholders If we expect EBIT to
9、 be less than the break-even point,then leverage is detrimental to our stockholders16-8Example:Break-Even EBIT$1.00500,000500,000EPS$500,000EBIT500,0002EBITEBIT250,000EBIT250,000500,000EBIT250,000250,000EBIT500,000EBIT16-9Example:Homemade Leverage and ROECurrent Capital StructureInvestor borrows$500
10、 and uses$500 of her own to buy 100 shares of stockPayoffs:Recession:100(0.60)-.1(500)=$10 Expected:100(1.30)-.1(500)=$80 Expansion:100(2.00)-.1(500)=$150Mirrors the payoffs from purchasing 50 shares of the firm under the proposed capital structureProposed Capital StructureInvestor buys$250 worth of
11、 stock(25 shares)and$250 worth of bonds paying 10%.Payoffs:Recession:25(.20)+.1(250)=$30 Expected:25(1.60)+.1(250)=$65 Expansion:25(3.00)+.1(250)=$100Mirrors the payoffs from purchasing 50 shares under the current capital structure16-10Capital Structure Theory Modigliani and Miller(M&M)Theory of Cap
12、ital Structure Proposition I firm value Proposition II WACC The value of the firm is determined by the cash flows to the firm and the risk of the assets Changing firm value Change the risk of the cash flows Change the cash flows16-11Capital Structure Theory Under Three Special Cases Case I Assumptio
13、ns No corporate or personal taxes No bankruptcy costs Case II Assumptions Corporate taxes,but no personal taxes No bankruptcy costs Case III Assumptions Corporate taxes,but no personal taxes Bankruptcy costs16-12Case I Propositions I and II Proposition I The value of the firm is NOT affected by chan
14、ges in the capital structure The cash flows of the firm do not change;therefore,value doesnt change Proposition II The WACC of the firm is NOT affected by capital structure16-13Case I-Equations WACC=RA=(E/V)RE+(D/V)RD RE=RA+(RA RD)(D/E)RA is the“cost”of the firms business risk,i.e.,the risk of the f
15、irms assets(RA RD)(D/E)is the“cost”of the firms financial risk,i.e.,the additional return required by stockholders to compensate for the risk of leverage16-14Figure 16.316-15Case I-Example Data Required return on assets=16%;cost of debt=10%;percent of debt=45%What is the cost of equity?RE=16+(16-10)
16、(.45/.55)=20.91%Suppose instead that the cost of equity is 25%,what is the debt-to-equity ratio?25=16+(16-10)(D/E)D/E=(25-16)/(16-10)=1.5 Based on this information,what is the percent of equity in the firm?E/V=1/2.5=40%16-16The CAPM,the SML and Proposition II How does financial leverage affect syste
17、matic risk?CAPM:RA=Rf+A(RM Rf)Where A is the firms asset beta and measures the systematic risk of the firms assets Proposition II Replace RA with the CAPM and assume that the debt is riskless(RD=Rf)RE=Rf+A(1+D/E)(RM Rf)16-17Business Risk and Financial Risk RE=Rf+A(1+D/E)(RM Rf)CAPM:RE=Rf+E(RM Rf)E=A
18、(1+D/E)Therefore,the systematic risk of the stock depends on:Systematic risk of the assets,A,(Business risk)Level of leverage,D/E,(Financial risk)16-18Case II Cash Flow Interest is tax deductible Therefore,when a firm adds debt,it reduces taxes,all else equal The reduction in taxes increases the cas
19、h flow of the firm How should an increase in cash flows affect the value of the firm?16-19Case II-ExampleUnlevered FirmLevered FirmEBIT5,0005,000Interest0500Taxable Income5,0004,500Taxes(34%)1,7001,530Net Income3,3002,970CFFA3,3003,47016-20Interest Tax Shield Annual interest tax shield Tax rate time
20、s interest payment 6,250 in 8%debt=500 in interest expense Annual tax shield=.34(500)=170 Present value of annual interest tax shield Assume perpetual debt for simplicity PV=170/.08=2,125 PV=D(RD)(TC)/RD=DTC=6,250(.34)=2,12516-21Case II Proposition I The value of the firm increases by the present va
21、lue of the annual interest tax shield Value of a levered firm=value of an unlevered firm+PV of interest tax shield Value of equity=Value of the firm Value of debt Assuming perpetual cash flows VU=EBIT(1-T)/RU VL=VU+DTC16-22Example:Case II Proposition I Data EBIT=25 million;Tax rate=35%;Debt=$75 mill
22、ion;Cost of debt=9%;Unlevered cost of capital=12%VU=25(1-.35)/.12=$135.42 million VL=135.42+75(.35)=$161.67 million E=161.67 75=$86.67 million16-23Figure 16.416-24Case II Proposition II The WACC decreases as D/E increases because of the government subsidy on interest payments RA=(E/V)RE+(D/V)(RD)(1-
23、TC)RE=RU+(RU RD)(D/E)(1-TC)Example RE=12+(12-9)(75/86.67)(1-.35)=13.69%RA=(86.67/161.67)(13.69)+(75/161.67)(9)(1-.35)RA=10.05%16-25Example:Case II Proposition II Suppose that the firm changes its capital structure so that the debt-to-equity ratio becomes 1.What will happen to the cost of equity unde
24、r the new capital structure?RE=12+(12-9)(1)(1-.35)=13.95%What will happen to the weighted average cost of capital?RA=.5(13.95)+.5(9)(1-.35)=9.9%16-26Figure 16.516-27Case III Now we add bankruptcy costs As the D/E ratio increases,the probability of bankruptcy increases This increased probability will
25、 increase the expected bankruptcy costs At some point,the additional value of the interest tax shield will be offset by the increase in expected bankruptcy cost At this point,the value of the firm will start to decrease,and the WACC will start to increase as more debt is added16-28Bankruptcy Costs D
26、irect costs Legal and administrative costs Ultimately cause bondholders to incur additional losses Disincentive to debt financing Financial distress Significant problems in meeting debt obligations Firms that experience financial distress do not necessarily file for bankruptcy16-29More Bankruptcy Co
27、sts Indirect bankruptcy costs Larger than direct costs,but more difficult to measure and estimate Stockholders want to avoid a formal bankruptcy filing Bondholders want to keep existing assets intact so they can at least receive that money Assets lose value as management spends time worrying about a
28、voiding bankruptcy instead of running the business The firm may also lose sales,experience interrupted operations and lose valuable employees16-30Figure 16.616-31Figure 16.716-32Conclusions Case I no taxes or bankruptcy costs No optimal capital structure Case II corporate taxes but no bankruptcy cos
29、ts Optimal capital structure is almost 100%debt Each additional dollar of debt increases the cash flow of the firm Case III corporate taxes and bankruptcy costs Optimal capital structure is part debt and part equity Occurs where the benefit from an additional dollar of debt is just offset by the inc
30、rease in expected bankruptcy costs16-33Figure 17.816-34Managerial Recommendations The tax benefit is only important if the firm has a large tax liability Risk of financial distress The greater the risk of financial distress,the less debt will be optimal for the firm The cost of financial distress va
31、ries across firms and industries,and as a manager you need to understand the cost for your industry16-35Figure 16.916-36The Value of the Firm Value of the firm=marketed claims+nonmarketed claims Marketed claims are the claims of stockholders and bondholders Nonmarketed claims are the claims of the g
32、overnment and other potential stakeholders The overall value of the firm is unaffected by changes in capital structure The division of value between marketed claims and nonmarketed claims may be impacted by capital structure decisions16-37The Pecking-Order TheoryTheory stating that firms prefer to i
33、ssue debt rather than equity if internal financing is insufficient.Rule 1Use internal financing firstRule 2Issue debt next,new equity lastThe pecking-order theory is at odds with the tradeoff theory:There is no target D/E ratioProfitable firms use less debtCompanies like financial slack16-38Observed
34、 Capital Structure Capital structure does differ by industry Differences according to Cost of Capital 2019 Yearbook by Ibbotson Associates,Inc.Lowest levels of debt Computers with 5.61%debt Drugs with 7.25%debt Highest levels of debt Cable television with 162.03%debt Airlines with 129.40%debt16-39Wo
35、rk the Web Example You can find information about a companys capital structure relative to its industry,sector and the S&P 500 at Reuters Click on the web surfer to go to the site Choose a company and get a quote Choose Ratio Comparisons16-40Bankruptcy Process Part I Business failure business has te
36、rminated with a loss to creditors Legal bankruptcy petition federal court for bankruptcy Technical insolvency firm is unable to meet debt obligations Accounting insolvency book value of equity is negative16-41Bankruptcy Process Part II Liquidation Chapter 7 of the Federal Bankruptcy Reform Act of 19
37、78 Trustee takes over assets,sells them and distributes the proceeds according to the absolute priority rule Reorganization Chapter 11 of the Federal Bankruptcy Reform Act of 1978 Restructure the corporation with a provision to repay creditors16-42Quick Quiz Explain the effect of leverage on EPS and
38、 ROE What is the break-even EBIT,and how do we compute it?How do we determine the optimal capital structure?What is the optimal capital structure in the three cases that were discussed in this chapter?What is the difference between liquidation and reorganization?16-43Ethics Issues Suppose managers o
39、f a firm know that the company is approaching financial distress.Should the managers borrow from creditors and issue a large one-time dividend to shareholders?How might creditors control this potential transfer of wealth?16-44Comprehensive Problem Assuming perpetual cash flows in Case II-Proposition I,what is the value of the equity for a firm with EBIT=$50 million,Tax rate=40%,Debt=$100 million,cost of debt=9%,and unlevered cost of capital=12%?16-45End of Chapter16-46 更多精品资请访问更多精品资请访问 更多品资源请访问更多品资源请访问
