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1、McGraw-Hill/IrwinCopyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.15-0Chapter Outline15.1 The Capital-Structure Question and The Pie Theory15.2 Maximizing Firm Value versus Maximizing Stockholder Interests15.3 Financial Leverage and Firm Value: An Example15.4 Modigliani and Mill
2、er: Proposition II (No Taxes)15.5 Taxes15.6 Summary and ConclusionsMcGraw-Hill/IrwinCopyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.15-1The Capital-Structure Question and The Pie Theory The value of a firm is defined to be the sum of the value of the firms debt and the firms eq
3、uity. V = B + SValue of the FirmSB If the goal of the management of the firm is to make the firm as valuable as possible, the the firm should pick the debt-equity ratio that makes the pie as big as possible. McGraw-Hill/IrwinCopyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.15-2T
4、he Capital-Structure QuestionThere are really two important questions:1. Why should the stockholders care about maximizing firm value? Perhaps they should be interested in strategies that maximize shareholder value.2. What is the ratio of debt-to-equity that maximizes the shareholders value?As it tu
5、rns out, changes in capital structure benefit the stockholders if and only if the value of the firm increases.McGraw-Hill/IrwinCopyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.15-3Financial Leverage, EPS, and ROE CurrentAssets $20,000Debt$0Equity $20,000Debt/Equity ratio0.00Inte
6、rest raten/aShares outstanding400Share price$50Proposed$20,000$8,000$12,0002/38%240$50Consider an all-equity firm that is considering going into debt. (Maybe some of the original shareholders want to cash out.)McGraw-Hill/IrwinCopyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.15-
7、4EPS and ROE Under Current Capital StructureRecessionExpectedExpansionEBIT$1,000$2,000$3,000Interest000Net income$1,000$2,000$3,000EPS$2.50$5.00$7.50ROA5%10%15%ROE5%10%15%Current Shares Outstanding = 400 sharesMcGraw-Hill/IrwinCopyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.15-
8、5EPS and ROE Under Proposed Capital StructureRecessionExpectedExpansionEBIT$1,000$2,000$3,000Interest640640640Net income$360$1,360$2,360EPS$1.50$5.67$9.83ROA5%10%15%ROE3%11%20%Proposed Shares Outstanding = 240 sharesMcGraw-Hill/IrwinCopyright 2002 by The McGraw-Hill Companies, Inc. All rights reserv
9、ed.15-6EPS and ROE Under Both Capital StructuresLeveredRecessionExpectedExpansionEBIT$1,000$2,000$3,000Interest640640640Net income$360$1,360$2,360EPS$1.50$5.67$9.83ROA5%10%15%ROE3%11%20%Proposed Shares Outstanding = 240 sharesAll-EquityRecessionExpectedExpansionEBIT$1,000$2,000$3,000Interest000Net i
10、ncome$1,000$2,000$3,000EPS$2.50$5.00$7.50ROA5%10%15%ROE5%10%15%Current Shares Outstanding = 400 sharesMcGraw-Hill/IrwinCopyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.15-7Financial Leverage and EPS(2.00)0.002.004.006.008.0010.0012.001,0002,0003,000EPSDebtNo DebtBreak-even point
11、 EBI in dollars, no taxesAdvantage to debtDisadvantage to debtEBITMcGraw-Hill/IrwinCopyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.15-8Assumptions of the Modigliani-Miller Model Homogeneous Expectations Homogeneous Business Risk Classes Perpetual Cash Flows Perfect Capital Mark
12、ets: Perfect competition Firms and investors can borrow/lend at the same rate Equal access to all relevant information No transaction costs No taxesMcGraw-Hill/IrwinCopyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.15-9Homemade Leverage: An ExampleRecession Expected ExpansionEPS
13、of Unlevered Firm$2.50$5.00$7.50Earnings for 40 shares$100$200$300Less interest on $800 (8%)$64$64$64Net Profits$36$136$236ROE (Net Profits / $1,200)3%11%20%We are buying 40 shares of a $50 stock on margin. We get the same ROE as if we bought into a levered firm.Our personal debt equity ratio is:322
14、00, 1$800$SBMcGraw-Hill/IrwinCopyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.15-10Homemade (Un)Leverage: An ExampleRecession Expected ExpansionEPS of Levered Firm$1.50$5.67$9.83Earnings for 24 shares$36$136$236Plus interest on $800 (8%)$64$64$64Net Profits$100$200$300ROE (Net P
15、rofits / $2,000)5%10%15%Buying 24 shares of an other-wise identical levered firm along with the some of the firms debt gets us to the ROE of the unlevered firm.This is the fundamental insight of M&MMcGraw-Hill/IrwinCopyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.15-11The MM Pro
16、positions I & II (No Taxes) Proposition I Firm value is not affected by leverageVL = VU Proposition II Leverage increases the risk and return to stockholdersrs = r0 + (B / SL) (r0 - rB)rB is the interest rate (cost of debt)rs is the return on (levered) equity (cost of equity)r0 is the return on unle
17、vered equity (cost of capital)B is the value of debtSL is the value of levered equityMcGraw-Hill/IrwinCopyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.15-12The MM Proposition I (No Taxes)ULVV BrEBITBreceive firm levered ain rsShareholdeBrBreceive sBondholderThe derivation is str
18、aightforward:BrBrEBITBB)(is rsstakeholde all toflowcash total theThus,The present value of this stream of cash flows is VL EBITBrBrEBITBB)(ClearlyThe present value of this stream of cash flows is VU McGraw-Hill/IrwinCopyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.15-13The MM Pr
19、oposition II (No Taxes)The derivation is straightforward:SBWACCrSBSrSBBr0set Then rrWACC0rrSBSrSBBSBSSBby sidesboth multiply 0rSSBrSBSSSBrSBBSSBSB0rSSBrrSBSB00rrSBrrSBSB)(00BSrrSBrrMcGraw-Hill/IrwinCopyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.15-14The Cost of Equity, the Cos
20、t of Debt, and the Weighted Average Cost of Capital: MM Proposition II with No Corporate TaxesDebt-to-equity RatioCost of capital: r (%)r0rBSBWACCrSBSrSBBr)(00BLSrrSBrrrBSBMcGraw-Hill/IrwinCopyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.15-15The MM Propositions I & II (with Cor
21、porate Taxes) Proposition I (with Corporate Taxes) Firm value increases with leverageVL = VU + TC B Proposition II (with Corporate Taxes) Some of the increase in equity risk and return is offset by interest tax shieldrS = r0 + (B/S)(1-TC)(r0 - rB) rB is the interest rate (cost of debt)rS is the retu
22、rn on equity (cost of equity)r0 is the return on unlevered equity (cost of capital)B is the value of debtS is the value of levered equityMcGraw-Hill/IrwinCopyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.15-16The MM Proposition I (Corp. Taxes)BTVVCUL )1 ()(receive firm levered ai
23、n rsShareholdeCBTBrEBITBrBreceive sBondholderBrTBrEBITBCB)1 ()(is rsstakeholde all toflowcash total theThus,The present value of this stream of cash flows is VL BrTBrEBITBCB)1 ()(Clearly The present value of the first term is VU The present value of the second term is TCB BrTBrTEBITBCBC)1 ()1 (BrBTr
24、BrTEBITBCBBC)1 (McGraw-Hill/IrwinCopyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.15-17The MM Proposition II (Corp. Taxes)Start with M&M Proposition I with taxes:)()1 (00BCSrrTSBrrBTVVCUL Since BSVLThe cash flows from each side of the balance sheet must equal:BCUBSBrTrVBrSr0BrTr
25、TBSBrSrBCCBS0)1 (Divide both sides by SBCCBSrTSBrTSBrSBr0)1 (1 BTVBSCU)1 (CUTBSVWhich quickly reduces toMcGraw-Hill/IrwinCopyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.15-18The Effect of Financial Leverage on the Cost of Debt and Equity CapitalDebt-to-equityratio (B/S)Cost of
26、capital: r(%)r0rB)()1 (00BCLSrrTSBrrSLLCBLWACCrSBSTrSBBr)1 (McGraw-Hill/IrwinCopyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.15-19Total Cash Flow to Investors Under Each Capital Structure with Corp. TaxesAll-EquityRecessionExpectedExpansionEBIT$1,000$2,000$3,000Interest000EBT$1
27、,000$2,000$3,000Taxes (Tc = 35%$350$700$1,050Total Cash Flow to S/H $650$1,300$1,950LeveredRecessionExpectedExpansionEBIT$1,000$2,000$3,000Interest ($800 8% )640640640EBT$360$1,360$2,360Taxes (Tc = 35%)$126$476$826Total Cash Flow $234+640$468+$640$1,534+$640(to both S/H & B/H): $874$1,524$2,174EBIT(
28、1-Tc)+TCrBB $650+$224$1,300+$224$1,950+$224$874$1,524$2,174McGraw-Hill/IrwinCopyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.15-20Total Cash Flow to Investors Under Each Capital Structure with Corp. TaxesThe levered firm pays less in taxes than does the all-equity firm.Thus, the
29、 sum of the debt plus the equity of the levered firm is greater than the equity of the unlevered firm.SGSGB All-equity firm Levered firmMcGraw-Hill/IrwinCopyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.15-21Summary: No Taxes In a world of no taxes, the value of the firm is unaff
30、ected by capital structure. This is M&M Proposition I:VL = VU Prop I holds because shareholders can achieve any pattern of payouts they desire with homemade leverage. In a world of no taxes, M&M Proposition II states that leverage increases the risk and return to stockholders)(00BLSrrSBrrMcGraw-Hill
31、/IrwinCopyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.15-22Summary: Taxes In a world of taxes, but no bankruptcy costs, the value of the firm increases with leverage. This is M&M Proposition I:VL = VU + TC B Prop I holds because shareholders can achieve any pattern of payouts t
32、hey desire with homemade leverage. In a world of taxes, M&M Proposition II states that leverage increases the risk and return to stockholders.)()1 (00BCLSrrTSBrrMcGraw-Hill/IrwinCopyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.15-23Prospectus: Bankruptcy Costs So far, we have se
33、en M&M suggest that financial leverage does not matter, or imply that taxes cause the optimal financial structure to be 100% debt. In the real world, most executives do not like a capital structure of 100% debt because that is a state known as “bankruptcy”. In the next chapter we will introduce the notion of a limit on the use of debt: financial distress. The important use of this chapter is to get comfortable with “M&M algebra”.