Analytical Methods for LawyersFinance UnitLast updated 01 Mar 07

Schedule

ClassTopic3/1IntroductionSpreadsheet primer3/6TVM future valueExercise 13/8TVM present valueExercise 23/20Discount rateExercise 33/22ECMHReadings 3/27Risk and returnExercise 43/29Valuation medical malpracticeGroup problem 14/3Valuation corporate appraisalGroup problem 2

Why the firm?

Theory of the FirmFirmCapitalLandEquipmentSuppliesLaborAdam SmithWealth of Nations

Why not contracting?

Theory of the FirmCapitalEntrepreneurLaborSuppliesLandEquipmentRonald CoaseNature of the Firm

Theory of the FirmCapitalEntrepreneurLaborSuppliesLandEquipmentRonald CoaseNature of the Firm

What is the modern public corporation?

Separation of ownership/controlEntrepreneurs(capitalist managers)CapitalLandEquipmentSuppliesLaborAdolf Berle & Gardiner Means

Separation of ownership/controlProfessional managersLandEquipmentSuppliesLaborAdolf Berle & Gardiner MeansCapital(diffuse publicownership)

What is ideal ownership debt or equity?

Optimal debt-equity mixManagersLandEquipmentSuppliesLaborFranco Modigliani &Merton MillerCost of CapitalDebtEquity

Optimal debt/equity mixNetAssetsDebtEquityDebt:PriorityFixed rate of return Optimaldebt/equity?Equity:Voting controlResidual returns

Optimal debt/equity mixNetAssetsDebtEquityLess debt:Large equity cushionLower risk lower costOptimaldebt/equity?More equity:Low leverageLower returns higher cost

Optimal debt/equity mixNetAssetsDebtEquityMore debt:Small equity cushionHigher risk higher costOptimaldebt/equity?Less equity:High leverageHigh returns lower cost

Modigliani & Miller

Return on AssetsCost of debtCost of equityAverage cost of capitalHigh D/E (90/10)15%14%24%15%Mid D/E (50/50)15%10%20%15%Low D/E (10/90)15%6%16%15%

Modigliani & Miller

Return on AssetsCost of debtCost of equityAverage cost of capitalHigh D/E (90/10)15%14%24%15%Mid D/E (50/50)15%10%20%15%Low D/E (10/90)15%6%16%15%

Modigliani & Miller

Return on AssetsCost of debtCost of equityAverage cost of capitalHigh D/E (90/10)15%14%24%15%Mid D/E (50/50)15%10%20%15%Low D/E (10/90)15%6%16%15%

Modigliani & Miller* Interest is deductible (debt subsidized by govt)

Return on AssetsCost of debtCost of equityAverage cost of capitalHigh D/E (90/10)15%14%24%15%*Mid D/E (50/50)15%10%20%15%Low D/E (10/90)15%6%16%15%

How unify ownership and management?

Leveraged firmManagersLandEquipmentSuppliesLaborMichael Jensen &William MecklingManagerial BehaviorOutsidedebtInside equity

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