topic 7 gangemi capital structure_1
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8/8/2019 Topic 7 Gangemi Capital Structure_1
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³WE LOVE FINANCIAL³WE LOVE FINANCIALTHEORY!!!´THEORY!!!´
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³OH, BOY!!´ TODAY WE LEARN³OH, BOY!!´ TODAY WE LEARNABOUT THE MM PROPOSITIONS!!´ABOUT THE MM PROPOSITIONS!!´
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WHICH PIE IS LARGER?WHICH PIE IS LARGER?
Shares
40%
Debt
60%Shares
60%
Debt
40%
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Topic 7 Capital Structure
Overview
This topic is concerned with the issue of whether
there exists an ³Optimal Capital Structure´, one
that maximizes the value of the firm.
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Capital Structurerepresents
The long-term sources of finance of the firm
Items found on the right hand side of the Balance
Sheet
The combination of debt and equity used to
finance the investment in real assets.
Established by financing decisions
Summarised by the Debt-to-equity ratio.
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The effect on equity holders of introducing
³Financial Leverage´ into the firm¶s capital
structure.
Financial Leverage refers to the extent to
which a firm relies on debt .
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Leverage (gearing) of a company can bemeasured using a leverage ratio:
Financial ³leverage´ (³gearing´)Financial ³leverage´ (³gearing´)
Leverage ratio !net debt
market capitalisation of equity
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Capital structuresCapital structures
The net debt to equity ratio of Wesfarmers Ltd
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ReturnsReturns
RETURN AVAILABL E TO SHA RE H O LD ER S
reflects the earning capacity of the firms assets
REQU I RE D R ATE OF RETURN TO SHA RE H O LD ER S
the minimum return demanded by shareholders given the
investment risk
reflects trade- off between risk and return
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Firm¶s Cash FlowsFirm¶s Cash Flows
REVENUE
Fixed operating costsFixed operating costsVariable operating costsVariable operating costs
InterestInterestNET INCOME
[NI]
lessless
equalsequalsNET OPERATING INCOMENET OPERATING INCOME
[NOI][NOI]
lessless
equalsequals
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Financing package Different levels of NOI ($000)
0 20 40 60 80
(a) All equity 0% 5% 10% 15% 20%
(b) 50% debt, 50% equity -10% 0% 10% 20% 30%
(c) 75% debt, 25% equity -30% -10% 10% 30% 50%
The below table shows the greater the debt to equity ratio
the greater the change in the available return to equity
holders as a result of a change in the level of Net Operating
Income (NOI)
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Effects Of Financial Leverage
T he substitution of debt for equity in the capital structure
(1) It increases the available return to equity holders canhave on their investment.
-This is due to the firms assets being able to earn areturn greater than the cost of debt.
(2) It increases the risk (variability of the returns)associated with the investment.
-Thus, the greater the range of returnsavailable to shareholders.
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Effects Of Financial LeverageEffects Of Financial Leverage
Having examined the impact of introducing debt wenow turn to examine how it could impact on thevalue of the firm through the firm¶s
Capital Structure
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Capital Structure
Optimal Capital Structure
The combination of debt and equity that minimises
WACC such that the value of the firm is maximised.
Is there such a combination?
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REAL ASSETS
GENERATE
A STREAM
OF
CASH FLOWS
- inventory
- machinery
- land & buildings
FINANCIAL ASSETS
CLAIMS
UPON THE
CASH FLOW
STREAM
- shares
- term loans
- mortgages
- debentures
Investing
Decision FinancingDecision
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Value of the FirmValue of the Firm
The firm may be valued by discounting the future cashThe firm may be valued by discounting the future cash
flows of the firm by the WACCflows of the firm by the WACC
VV ==nn
77t = 1t = 1
NOINOItt
(1 + r)(1 + r)ttVV ==
nn
77t = 1t = 1
(Revenues(Revenues -- Costs)Costs)tt
(1 + r)(1 + r)tt
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VV ==NOINOI
rr
e.g. Equity and debt
rr = r= ree ( ) + r( ) + rdd ( )( )EE
VV
DD
VV
SIMPLIFY BY ASSUMING NOI IS CONSTANT
We can now express the equation as a perpetuity.
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Value of the FirmValue of the Firm
As Net Operating Income increases the value of the firmincreases.
Net Operating Income reflects the Investment decision
of the firm
As the Weighted Average Cost of Capital decreases theValue of the firm increases. (Inverse relationship)
WACC reflects the Financing decision of the firm
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Value of the FirmValue of the Firm
THE BIG QUESTION TO CONSIDER:
Does substitution of cheaper debt
finance for equity reduce the overallweighted average cost of capital andthereby increase the value of the firm?
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Why Is Debt Cheaper Than Equity?Why Is Debt Cheaper Than Equity?
1. Debt holders have priority over equity holders intheir claims on the firm¶s cash flow stream.
2. Debt is a contractual claim
3. Common stock dividends are a residual claim
4. Lenders therefore face lower risk than equity
investors.
Consequently, the return required by debt holders
(lenders) is less than the return required by
shareholders
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TRADITIONAL APPROACHTRADITIONAL APPROACH
The traditional approach to capital structure assumes that there isan optimal capital structure and management can increase thetotal value of the firm through the financing method.
The approach implies that the cost of capital is dependent on thecapital structure of the firm.
However, this is a practical approach without a theoretical basis.
The determinants of, or path to, the optimal D/E ratio were neverspecified (no formal model has been developed.)
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The Traditional View Of TheThe Traditional View Of TheEffect Of LeverageEffect Of Leverage
As the amount of debt increases, this initiallyreduces the WACC (because debt is cheaper thanequity)
However, the cost of debt is not constant but atsome point increases.
The required rate of return that shareholdersdemand also increases as the level of debt increasesand this offsets the initial reduction in WACC.
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The Traditional View Of TheThe Traditional View Of TheEffect Of LeverageEffect Of Leverage
Traditional view - there is an optimal capitalstructure.
It is where WACC is at a minimum andconsequently the value of the firm is at amaximum
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The Traditional View Of The Effect Of The Traditional View Of The Effect Of LeverageLeverage
Cost of
Capital
LeverageD/V
0
(a) The Effect on the Cost of Capital
r e
r d
r
TotalValue
Leverage0DV
(b) The Effect on Firm Value
V
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Example:Example: Cost of capital and leverageCost of capital and leverage
r = rd (D/V) + re (E/V)
0.086 = 0.05(10/100) + 0.090 (90/100)
0.084 = 0.05(25/100) + 0.095 (75/100)
0.075 = 0.05(50/100) + 0.10 (50/100)
BUT
0.077 = 0.07(90/100) + 0.14 (10/100)
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Modigliani (Franco,) and Miller (Merton,) TheModigliani (Franco,) and Miller (Merton,) TheOriginal M and M (Before MarshallOriginal M and M (Before Marshall MathersMathers))
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Modigliani and Miller (M&M)Modigliani and Miller (M&M)
Questioned the traditional view
M and M examined the relationship between
firm value and financing choice
Analysis based on perfect market (oh,oh!)
assumptions
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Modigliani and Miller (M&M)Modigliani and Miller (M&M)
M and M undertook studies of electricutilities and oil companies.
E vidence supported conclusion thatthere was no relationship between D/Eratios and cost of capital in these
industries
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ASSUMPTIONS UNDERLYINGASSUMPTIONS UNDERLYINGM & M ANALYSISM & M ANALYSIS
1. a perfectly competitive market in which all investors haveperfect knowledge and act rationally;
2. investors are perfectly certain about the future profitability
of any company
3. all companies can be divided into homogenous risk classes
4. no personal or company tax
5. individuals and companies can raise unlimited debt funds atthe same rate of interest
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M&M Proposition 1M&M Proposition 1 In perfect capital markets (with no taxes and no bankruptcy
costs) the value of the firm is independent of its capital structure.(i.e. Capital structure is irrelevant.)
1. The WACC does not vary with changes in the debt/equity ratio.
2. A firm cannot change its total value just by dividing its cash flows into
different streams (different classes of investors).3. The firm's value is determined by its real assets, not by the securities it
issues.
4. Claims on firms in same business risk class and with same earningsstreams are perfect substitutes and must sell for the same value -otherwise could make arbitrage profits.
PROVIDED
Personal borrowing is a perfect substitute for corporate borrowing.
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MM Proposition IMM Proposition I
Shares40%
Debt
60%
The size of the pie does not depend on how it is sliced.
The value of the firm is unaffected by its capital structure.
Value of firm Value of firm
Sha es
60%
De
40%
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M&M Proof Of Capital StructureM&M Proof Of Capital StructureIrrelevance In Perfect Capital MarketsIrrelevance In Perfect Capital Markets
IMPORTANT POINT!
Example:
Firm L and firm U have identical assets capable of generatingidentical cash flows . T he only difference is that Firm L is morehighly levered.
± If Firm L has the same cost of equity as firm U, and uses cheaper debt, itwill have a lower WACC its value will be higher than Firm U
± Investors will sell their shares in Firm L and buy equivalent cash flowstream in Firm U thus making an arbitrage profit. The sale of Firm L shareswill cause Firm L¶s price to fall. The increase demand of Firm U¶s shares will
cause Firm U¶s price to rise.
T he process will continue until the value of each firm is the same.
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Irrelevance PropositionIRRELEVANCE PROPOSITION
Assume two firms with the same business risk and the same NOI
Un-levered FirmNOI = $2,000 re =10%
Vu = $20,000
Levered Firm
D = $10,000 rd = 5%
NOI = $2,000 re =10%
Interest = $500
NI = $1,500
E = 1,500/0.1 = $15,000
VL = $10,000 + $15,000= $25,000
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Assume they own 10% Equity (E) of the levered Firm, (i.e.
$1,500 which provides a 10% claim on NIL of $150)
The operation
1. Sell E in the levered firm for $1,500
2. Borrow $1,000 at 5%
D/E =1000/1500 =2/3
Same as levered Firm
3. Buy 10% of the E in the un-levered firm for $2,000
The Arbitrager
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Arbitrage Results
(i) Receives 10% of the income of the un-levered firm = $200
(ii) Pays $50 interest on personal borrowing
(i) + (ii) implies individual receives net $150 which is what individual
was receiving from their share in the un-levered firm.
NB: Individual had available $2,500
(D = $1,000, E = $1,500) used $2,000 to buy shares in un-leveredfirm which means that $500 still available to earn income on!!!
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M & M Proposition 1
Cost of Capital
Leverage0
( a)Th
eEff
ect on
t he
Cost
of C apital
r e
r d
r
TotalValue
Leverage0
(b ) The Eff ect on F irm V alue
V
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M&M Proposition 2M&M Proposition 2
How does the required return on
equity in a levered firm change as
the degree of leverage changes?
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M&M Proposition 2M&M Proposition 2
The required rate of return by equity
holders can be shown to be equal to the
required rate of return for un-levered
equity plus the ³financial risk
premium´ which is a function of thedebt-equity ratio.
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Assume NOIu = NOIL
From M & M Theorem 1 Vu = VL
Vu = NOIu / r*e r
r*e is the required return on equity capital in a firm with no debt (pure
equity firm)
VL = NOIL / r
Where r is the required rate of return on capital ( both debt and
equity) in a levered firm.
r = rd (D/V) + re (E/V)
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Since from Modigliani and Miller
we know thatVu = VL we require that
r*e = r = rd (D/V) + re (E/V)
r*e = rd (D/V) + re (E/V)
Solving for re
re= r*e + ( r*e ± rd).D/E
We recognize that in an all equity firm r*e = raf
Therefore re = raf +(raf ±rd).D/E
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Assume a Modigliani and Miller world
with no taxes where the required rateof return of an un-levered firm is 9.6%.
What is the cost of equity in an
identical levered firm where the cost of
debt is 7% and the D/V ratio is 0.5?
a. 10.8%
b. 12.20%c. 10%d. 13.5%
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0.096 = (0.5)(0.07) + (0.5)(x)
.096 = .035 + 5x
.096 - .035 = .035-.035+5x
.061 = .5x
x - .1220 or r^e = 12.20%
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M&M Proposition 2M&M Proposition 2
This shows that as the degree of
leverage increases the required rate
of return on equity in a levered firm
increases exactly in line with the
increase in the available rate of
return
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For capital structure to be irrelevant
the return equity holders require on
their investment mustincrease inline with the return available to
them.
Returns to Equity
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As µcheaper¶ debt is substituted for
equity in the capital structure, the
return required by the equity holdersincreases in response to the increased
risk associated with their investment,
and thereby (exactly) offsets the effecton the overall cost of capital of the
µcheaper¶ debt finance.
Returns to Equity
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ExampleExample
Capital structure: equity = 40% debt = 60% rd = 8%
assume business risk re* = 8.8%
re = re* + (re* - rd) D/E
re = 8.8% + (8.8% - 8%) 6/4
re = 10%WACC = re (E/V) + rd (D/V)
= 10% x 40/100 + 8% x 60/100
= 4% +4.8%
= 8.8%
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ExampleExample
If capital structure changes so debt increases to 70%,
M & M argue that this will increase the financial risk to
shareholders and their required rate of return will increase.
re = re* + (re* - rd) D/E
re = 8.8% + (8.8% - 8%) 7/3
re = 10.67%
When capital structure changes
WACC = 10.67% x 30/100 + 8% x 70/100
= 3.2% + 5.6%
= 8.8% no change in WACC
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Type of RisksType of Risks
NO DEBT: NOI = NI (all variability in net incomecomes from business risk).
DEBT: when the firm borrows, it becomes subjectto financial risk and business risk; interestis subtracted from the NOI, the effect beingan increase in the variability of the NIstream.
= an additional source of risk
= shareholder expected return increases
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BUSINESS RISK :risk due to nature of the products sold by the company e.g.
new competition, technological improvements, etc.
FINANCIAL RISK:
risk due to using debt (directly related to amount of debt inthe capital structure).
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Decomposition Of EquityDecomposition Of EquityHolders¶ Required ReturnsHolders¶ Required Returns
re = RF + BRP + FRP
Return on aReturn on a
Risk Risk--freefree
investmentinvestment
Premium forPremium for
Business Risk Business Risk
Premium forPremium for
Financial Risk Financial Risk
Risk inherent in
firm¶s operations
Risk introduced through the addition of
debt into the capital structure
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Thus, the expected return to equity holders is equal
to the required rate of return for unlevered equityplus the financial risk premium which is a functionof the debt-equity ratio.
re = return to equity holdersre*= rate of return required by shareholders in a un-levered
firm
rd = rate of return required by debt holders
M and M Proposition 2M and M Proposition 2
DDEE
rree == rree* + (r* + (ree** -- rrdd))
BusinessRisk
FinancialRisk
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Conclusion from Proposition 2Conclusion from Proposition 2
1. Increasing leverage does not affect the cost of
capital
2. The cost of debt is an explicit cost included inthe cost of capital.
3. The financial risk created by leverage is an
implicit cost of debt which increases the cost of
capital by increasing the required rate of
return by equity holders.
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Summary
Capital Structure Irrelevance
r
NOIV !
WACC
¹ º ¸©
ª¨¹
º ¸©
ª¨!
V
Er V
Dr r ed
Constant Proportions changing
? A ¹ º
¸©ª
¨! E
D
r r r r d*e*ee
varies linearly (and positively) with changes in financial
leverage and offsets the effect on r of the lower cost,dr
er
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M&M Proposition 3M&M Proposition 3
The appropriate discount rate for a particular
investment proposal is completely independent of
how the investment is financed. Therefore, thefinancing decision is irrelevant from the point-of-
view of maximising shareholder wealth.
The appropriate discount rate depends on the
features of the investment proposal, especially risk .
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INTRODUCTION TO MARKETINTRODUCTION TO MARKETIMPERFECTIONSIMPERFECTIONS
Capital structure Decision with CorporateCapital structure Decision with CorporateTaxationTaxation
M & M introduced corporate taxes
conclusion:
interest is tax deductible
thus borrowing represents a tax saving
thus the value of the levered firm is greater than the valueof the un-levered firm by the value of the present value of the tax benefits
or VL > VU
where VL = VU + P.V. of the tax savings oninterest
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Imperfect Capital MarketsImperfect Capital MarketsCorporate TaxesCorporate Taxes
Levered firms have additional taxdeductions associated with the interestpayments
Value of the levered firm will be greater thanthe value of the un-levered firm by thepresent value of the tax benefits
Implies existence of an optimal capitalstructure - ALL DEBT
NotationNotation
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NotationNotation
Vu = value of an un-levered firm
VL = value of a levered firm
rd = rate of return required by debt holders
re* = rate of return required by shareholdersin an un-levered firm
re = rate of return required by shareholdersin a levered firm
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Vu =
VL
=
VL =
VL =
NOI (1 - tc)
re*
NOI (1 - tc)
re*
NOI (1 - tc)
re*
(rd) (D) tc
rd
+
+ D tc
+ D tcVu
Present value of the
interest tax shield
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Modigliani & Miller AnalysisModigliani & Miller Analysis Introduction of Corporate T axes Introduction of Corporate T axes
VV
00DD
EE
VVLL
VVuu
PresentV
alue of PresentV
alue of Interest Tax ShieldsInterest Tax Shields
(D t(D tcc))
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Cost Of CapitalCost Of Capital
Optimal capital structure will be 100% debt. This willminimise the cost of capital and thereby maximise the value
of the firm.
rr
WACCWACC
DDEE
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Why Are All Debt Capital Structures NotWhy Are All Debt Capital Structures NotObserved?Observed?
There must be factors that offset the taxadvantages of debt finance when borrowingbecomes too high:
1. Personal Taxes
2. Financial Distress Costs
3. Conflict of Interest Costsetc.
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The impact of the introduction of personal taxes is beyond thescope of this course.
A formal analysis of personal taxes is contained in the appendix tothis topic.
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In SummaryIn Summary
If corporate taxes are introduced to be consistent need toalso consider the impact of personal taxes.
Need to consider the way in which the corporate tax system
and the personal tax system are integrated, in particular asregards the treatment of dividends
e.g. are dividends taxed twice?
is there a dividend imputation system in place?
Need to consider whether equity income is treated morefavourably than debt income by the personal tax system.
How are capital gains taxed?
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Depending on the exact nature of the overall tax system can endwith a variety of results.
If the tax system is perfect, in the sense that an individual pays thesame amount of tax whether they receive a dollar of debt incomeor a dollar of equity income, then its back to the originalModigliani Miller result in that the capital structure does not
matter.
If Dividends are taxed twice once at the company level and once atthe individual level ( Classical Tax system) then could be back tothe conclusion the more debt in the capital structure the greaterthe value of the firm.
If debt income is treated more ( less) favourably by the tax systemthan equity income an increase in debt (equity) will increase the
value of the firm
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2. Financial Distress Costs2. Financial Distress Costs
Financial Distress:
When a firm cannot meets itscreditors commitments
Financial Distress Costs:
Costs of managerial time devoted to avert failure, fees paid to
insolvency specialists, etc.
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Direct vs Indirect Bankruptcy CostsDirect vs Indirect Bankruptcy Costs
Direct costs
T hose costs are directly associated with bankruptcy,eg legal and administrative expenses.
Indirect costsT hose costs associated with spending resources toavoid bankruptcy.
The static theory of capital structure
A firm borrows up to the point where the tax benefit from an extra dollar in debt is exactly equal to thecost that comes from the increased probability of financial distress.
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2. Financial Distress Costs2. Financial Distress Costs
As debt increases to a point where there us a possibility of financial distress and the F.D.C. increase, there is anoffsetting effect, i.e. the P.V. of the F.D.C. offset the P.V. of the interest tax shields.
where VL = VU
+ PV of the Tax Saving on Interest
- P.V. of the F.D.C.
At the point where this offsetting begins we find the optimalcapital structure for a firm.
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2. Financial Distress Costs2. Financial Distress CostsValue of the firm
(VL)
VL+ VU + TC x D
Financial distress costs
Actual firm
value
VU = Value of firm
with no debt
Total debt
(D)D*
Optimal amount
of debt
VU
Maximum
firm value VL*
The gain from the tax shield on debt is offset by financial distress costs. An
optimal capital structure exists which just balances the additional gain from
leverage against the added financial distress cost.
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3. Conflict Of Interest Costs3. Conflict Of Interest Costs
Debt holders may fear management will transfer wealthfrom themselves to shareholders.
± They need to protect themselves from erosion of wealth(increase rd or impose covenants)
± this is likely to increase as the D/E ratio increases
± these costs are part of financial distress costs
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APPENDIX A . Personal Taxes (Miller 1977)APPENDIX A . Personal Taxes (Miller 1977)
analysis based on the classical tax system
assumed re equals zero ( rd and tc are important)
investors are risk-neutral and debt is risk-less
there are different clienteles of investors (based on personal tax rate)
Investors face a choice of either
± a) tax-exempt Govt. bonds or
± b) investment in risky firms
± To entice investors to invest in debt rather than equity, the firm must offerhigh enough returns (before tax) to offset the disadvantage of higher
personal tax rates.
This counterbalances the interest deductibility of debt (the shareholders of levered firms end up receiving no benefit from the tax deductibility of intereston corporate debt because the firms are in effect forced to pay debt holderspersonal taxes in the form of higher returns).
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1. Personal Taxes (Miller 1977)1. Personal Taxes (Miller 1977)
Any gain from leverage on the relationship between two typesof personal taxes and the corporate tax rate.
VVLL = V= Vuu + D.t+ D.tcc
where (1where (1 -- ttcc) (1) (1-- ttpsps)) == afterafter--tax return to shareholderstax return to shareholders
(1(1 -- ttpdpd)) == afterafter--tax return to debt holderstax return to debt holders
= = VVuu ++ [[11 -- ]] DD(1(1 -- ttcc) (1) (1 -- ttpsps))
(1(1 -- ttpdpd))
DD[ ][ ] == GGLL (gain or leverage)(gain or leverage)11 -- (1(1 -- ttcc) (1) (1 -- ttpsps))
(1(1 -- ttpdpd))
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1. Personal Taxes (Miller 1977)1. Personal Taxes (Miller 1977)
A point is reached where
(1 - tc) (1- tps) = (1 - tpd)
At this point the gain from leverage is zero and theadvantage of issuing more debt vanishes completely.
At this point a capital structure is optimal
Because this level of debt is optimal for all firms, the D/E isoptimal for the economy as a whole, not for the individual
firm.
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Miller¶s Analysis Corporate &Miller¶s Analysis Corporate &Personal TaxesPersonal Taxes
00 DD
VVLL = V= Vuu ++ [1[1 -- ]] DD(1(1 -- ttcc) (1) (1 -- ttpsps))
(1(1 -- ttpdpd))
VVLL
VVuu
VVLL = V= Vuu + D t+ D tcc IF IF ttpsps = t= tpdpd
VVLL > V> Vuu IF IF (1(1 -- ttpdpd) > (1) > (1 -- ttcc) (1) (1 -- ttpsps))
VVLL = V= Vuu IF IF (1(1 -- ttpdpd) = (1) = (1 -- ttcc) (1) (1 -- ttpsps))
VVLL < V< Vuu IF IF (1(1 -- ttpdpd) < (1) < (1 -- ttcc) (1) (1 -- ttpsps))
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Example
Assume that there are 3 identical firms, a , b and c.
Identical in all respects apart from the way in which the firmis financed.
No corporate taxation
In each case the firm has total assets of $400,000 and but themix of debt and equity used to finance these assets differ
We assume that the return that the firm can earn on itsassets in each case is the case, 15%
Therefore Net operating Income of all 3 firms is the same at
$60,000The firms that use debt pay 10% interest
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(a)All equity
$
(b)50 debt
50 equity
(c)75% debt
25 % equity
Equity 400,000 200,000 100,000
Debt 200,000 300,000
Total Assets 400,000 400,000 400,000
Debt/Equity ratio 0 1:1 3:1
Net operating Income 60,000 60,000 60,000
Interest (at 10%) 20,000 30,000
Net Income 60,000 40,000 30,000
Return on Assets 15% 15% 15%
Available Return on
Equity
15% 20% 30%
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The previous analysis can be captured in algebraic
form:
Let = return available to equity holders
= return provided by the firms assets
aer
af r
E
Dr EDr r
daae
!
E
Dr r r r daaae !
!aer
et cash low - interest
rom irms assets payments
equity investments
=
( ) ( ) ( )
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(a)
All equity
$
(b)
50% debt
50% equity
(c)
75% debt
25 % equity
Equity 400,000 200,000 100,000
Debt 200,000 300,000
Total Assets 400,000 400,000 400,000
Debt/Equity ratio 0 1:1 3:1
Net operating Income 36,000 36,000 36,000
Interest (at 10%) 20,000 30,000
Net Income 36,000 16,000 6,000
Return on Assets 9% 9% 9%
Available Return on Equity 9% 8% 6%
Change in available
return on equity-40% -60% -80%
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What happens to the available return toequity holders as result of the return earned
on the firms assets decreasing?
1. Initially the return on the firms assets of $400,000 was
15% giving a NOI of $60,000. We now assume the returnon assets falls to 9% giving a NOI of $36,000
2. It will be shown that the greater is the D/E ratio the
greater the drop in the available rate of return to equityholders