Documentos de Académico
Documentos de Profesional
Documentos de Cultura
Homogeneous expectations
Homogeneous business risk (sEBIT) classes
Perpetual no-growth cash flows
Perfect capital markets:
Business Risk
Business risk:
Principle of Additivity
The concept:
PV[A + B at RADR appropriate to (A + B)]
= PV(A at RADR appropriate to A)
+ PV(B at RADR appropriate to B).
FIN 591: Financial Fundamentals/Valuation
Additivity Example
Asset
A
B
1-Period
E(payoff)
$100
$150
Beta
1
2
M&M Proposition I:
re = ru + (ru - rb) B / S
rb
re
ru
B
S
Also, defined as
= cost of debt
return on assets
= cost of equity
= cost of capital for all-equity firms in this risk class
= value of debt
= value of stock or equity.
Financing Alternatives
Unlevered
Equity
Debt (rb = 5%)
Cash Flows
EBIT
Interest
EBT
Tax (0%)
Net income
$5,000
$4,000
$1,000
$1,000
$1,000
50 = (.05)1,000
950
1,000
Levered
1,000
950
$1,000
$1,000
Proposition I: VL = VU
VU
VL
VU
VL
Debt
Required return on equity (Proposition II)
re
Slope = (ru rb )
ru
WACC
Debt/equity
FIN 591: Financial Fundamentals/Valuation
10
M&M Proposition I:
VL = VU + t C B
11
Unlevered
$1,000
1,000
660
Levered
$1,000
50 = (.05)1,000
950
340 323
627
$ 660
$ 677
12
Company pays $1 * (1 - t)
Government pays $1 * t
Example:
Income tax savings = Interest expense * t
= $50 * .34 = $17
13
Proposition I: VL = VU + tC B
VU = EBIT (1 tC) / ru = $660 / .1 = $6,600
VL = VU + t C B = $6,600 + $340 = $6,940
S = VL B = $5,940.
14
Confirmation
VL = B + S
= rb B / rb + (EBIT rd B) (1 tc) / re
= $50 / .05 + ($1,000 $50) (1 .34) /
.10556
= $1,000 + $5,940 = $6,940
15
Debt
Required return on equity (Proposition II)
re
Slope = (1 tc )(ru rb )
ru
rb
WACC
Debt/equity
FIN 591: Financial Fundamentals/Valuation
16
Another Look
with Corporate Taxes
Market Value Balance Sheet (All equity firm)
Physical assets = $1,000(1 .34)/(.1)
=
$6,600
Equity = $6,600
(1,000 shares at $6.60)
$6,600
$340
$6,940
Equity = $6,940
(1,000 shares at $6.94)
$6,600
Equity = $5,940
(855.91 shares at $6.94)
$340
$6,940
Debt = $1,000
Debt plus equity
= $6,940
17
An Aside:
Why?
18
Millers Argument
tb
If (1 - tc) (1 - ts) / (1 - tb) < 1
Need ts <
19
20
21
M&M:
VL = VU + tc B
Miller:
22
VL = VU + TcB when TS = TB
VL = VU + [1 - (1 - Tc)(1 - TS)/(1 - TB)]B
when (1 - TB) > (1 - Tc)(1 - TS)
Vu
Debt (B)
Tc = corporate tax rate
TB = personal tax rate on interest
TS = personal tax rate on dividends & other equity distributions.
FIN 591: Financial Fundamentals/Valuation
23
Relationship Between
Firm Value and WACC
Assumes
ts = tb
Earnings perspective
Financing perspective.
24
Assumptions:
WACC
= Constant cash operating profits * (1 - tc)
Market value of unlevered firm
= $660 / $6,600 = 10% (see slide #9)
WACC
= Constant cash operating profits * (1 - tc)
Market value of levered firm
= $660 / $6,940 = 9.51% (see slide #14).
FIN 591: Financial Fundamentals/Valuation
25
Debt
Preferred stock
Common stock
26
...
$70
6/97
12/97
$70
$70
$70
6/98 12/98
12/07
$1000
$70
$70
6/08
12/08
27
$1,100
$1,000
6.17
28
Cost of Debt
Example:
A firms debt trades in the market to provide a
YTM of 5%. If the firms tax rate is 34%, how
much is the after-tax cost of debt?
Answer: 5% * (1 - .34) = 3.30%.
FIN 591: Financial Fundamentals/Valuation
29
Thus,
See
30
Example:
A preferred stock (par = $20) pays a $3
dividend annually. It currently trades in the
market for $24. How much is the cost of the
stock from the firms perspective?
Answer: $3 / $24 = 12.5%.
FIN 591: Financial Fundamentals/Valuation
31
Cost of Equity
M&M model
Build-up approach.
FIN 591: Financial Fundamentals/Valuation
32
33
34
Growth Rate
Arithmetic return:
Geometric return:
35
Price =
Example:
A firms stock currently sells for $25 per
share. The forecast for next years dividend is
$1 and this dividend is expected to grow 10%
annually.
Answer: $1 / $25 + .10 = .14 or 14%.
FIN 591: Financial Fundamentals/Valuation
36
Assume:
37
Market
38
The End
39