7.0 does debt policy matter(1)

8/12/2019 7.0 Does Debt Policy Matter(1)

1/22

Chapter17

Does Debt PolicyMatter?

Slides by

Matthew Will

McGraw-Hill/Irwin Copyright 2011 by the McGraw-Hill Companies, Inc. ll rights reser!e".


2/22

Topics Covered Financial Leverage in a Competitive Tax

Free Environment

Financial Risk and Expected Returns The Weighted Average Cost of Capital A Final Word on After Tax WACC


3/22

M&M !e"t #olic$ !oesn%t Matter Modigliani & Miller

When there are no taxes and capital marketsfunction 'ell( it makes no difference 'hetherthe firm "orro's or individual shareholders"orro') Therefore( the market value of acompan$ does not depend on its capital

structure)


4/22

M&M !e"t #olic$ !oesn%t MatterAssumptions *$ issuing + securit$ rather than ,( compan$

diminishes investor choice) This does not reducevalue if-

.nvestors do not need choice( /R There are sufficient alternative securities

Capital structure does not affect cash flo's e)g))) 0o taxes 0o "ankruptc$ costs 0o effect on management incentives


5/22

M&M !e"t #olic$ !oesn%t Matter

Profits01.01V.urnDollar RetInvestmentDollar

U

L

LL

L

L

01V.Profits01.)E01(D.Total

Interest)-Profits(01.01E.EquityInterest.0101D.De t

ReturnDollarInvestmentDollar

= +


6/22

M&M !e"t #olic$ !oesn%t Matter

).01(Vinterest)-Profits(01.01E.

urnDollar RetInvestmentDollar

LL

L

D=

Interest)-Profits(01.)D01(V.Total

Profits01.01V.EquityInterest.01-01D.!orro"in#

urnDollar RetInvestmentDollar

LU

U

L

+


7/22

Example 1 Mac"eth 2pot Removers 1 All E3uit$Financed

M M !Debt Policy Doesn"t Matter#

E$%e&te'out&ome

0110*(*)s+aresonReturn.001. 01.00,. 0s+are %erEarnin#s

0001 001 000, 00In&ome%eratin# D/ !

ut&omes

10 000,+aresof Value2ar3et

,10s+are %erPri&e1 000s+aresof 4um er

Data


8/22

Example cont)456 de"t


30 20100#$#%shareson &et'rn

51,0s+are %erEarnin#s0011 00000,0earnin#sEquity

000000, 00Interest 0001 001 000, 00In&ome%eratin#

/!

ut&omes

000,'e tof ue2ar3et val000,+aresof Value2ar3et

,10s+are %erPri&e00s+aresof 4um er

Data

D


9/22

Example 1 Mac"eth%s 1 All E3uit$ Financed1 !e"t replicated "$ investors


(020100#$#%in!estment )10on &et'rn

5.00.001.000,investmentonearnin#s 4et1.001.001.00,1.0010*6Interest7LE

8.005.00.00,1.00s+arest"oonEarnin#sD/!

ut&omes


10/22

$orrowin% and EPS at Macbeth


11/22

MM72 #R/#/2.T./0 .

.f capital markets are doing their 8o"( firms cannot increase value "$ tinkering

'ith capital structure) 9 is independent of the de"t ratio)

A0 E9ER:!A: A0AL/;:

.t should cost no more to assem"le a chicken than to "u$ one 'hole)

0o Magic in Financial Leverage


12/22

#roposition . and Mac"eth

Macbeth contin'e"

01(*)s+are %erreturnE$%e&te'1010(,)s+are %erPri&e.001. 0(,)s+are %erearnin#sE$%e&te'

Equityan'De tEqual7tru&turePro%ose'

Equityll7tru&ture/uttent


13/22

Leverage and Returns

se&uritiesallof uemar3et valin&omeo%eratin#e$%e&te'

r assetsonreturnE$%e&te' a ==

+

+

+

= E D A r E D

E r

E D

Dr


14/22

M&M #roposition .. Macbeth contin'e"

1.00010

1 00se&uritiesallof uemar3et val

in&omeo%eratin#e$%e&te'r r E

==

==

( ) E

Dr r r r

D A A E +=


15/22

M&M #roposition .. Macbeth contin'e" ( ) E

Dr r r r D A A E +=

1.00010

1 00se&uritiesallof uemar3et valin&omeo%eratin#e$%e&te'

r r E

==

==

( )0*or0.

00000010.1.1.

=+= E r


16/22

Leverage and Risk

Macbeth contin'e" Levera#e in&reases t+e ris3 of 2a& et+ s+ares

0*-00*s+aresonReturn, .00-0(,)s+are %erEarnin#s7'e t*010*-*1 *s+aresonReturn,1.00-0. 01. 0(,)s+are %erEarnin#sequityll

/+an#e, 00In&ome

to,1 00%eratin#


17/22


sset Value 100 De t (D) 80

Equity (E) 90

sset Value 100 :irm Value (V) 100

r' ;


18/22


sset Value 100 De t (D) 80

Equity (E) 90

sset Value 100 :irm Value (V) 100

r' ;

2ar3et Value !alan&e +eet e$am%le ? &ontinue'

@+at +a%%ens to Re "+en 'e t &osts rise>

*0.1910090

100800


19/22


+

=

V

E B

V

D B B

E D A

( ) D A A E B BV D

B B +=


20/22

WACC

@ // is t+e tra'itional vie" of &a%italstru&ture- ris3 an' return.

+

==

V

E r

V

Dr r WACC

E D A


21/22

M&M #roposition ..


22/22

WACC traditional vie'

7.0 does debt policy matter(1)

Documents