“you can’t argue with a river, it is going to flow. you can dam it [or] deflect it, but you...

“You can’t argue with a river, it is going to flow. You can dam it [or] deflect it, but you can’t argue with it.”—Dean Acheson So it is with Modigliani- Miller…

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“You can’t argue with a river, it is going to flow. You can dam it [or] deflect it, but you can’t argue with it.”—Dean Acheson

So it is with Modigliani- Miller…

Page 3: “You can’t argue with a river, it is going to flow. You can dam it [or] deflect it, but you can’t argue with it.”— Dean Acheson So it is with Modigliani-

Page 4: “You can’t argue with a river, it is going to flow. You can dam it [or] deflect it, but you can’t argue with it.”— Dean Acheson So it is with Modigliani-

Page 5: “You can’t argue with a river, it is going to flow. You can dam it [or] deflect it, but you can’t argue with it.”— Dean Acheson So it is with Modigliani-

Page 6: “You can’t argue with a river, it is going to flow. You can dam it [or] deflect it, but you can’t argue with it.”— Dean Acheson So it is with Modigliani-

Page 7: “You can’t argue with a river, it is going to flow. You can dam it [or] deflect it, but you can’t argue with it.”— Dean Acheson So it is with Modigliani-

Practical Considerations

Impact on income statement/eps Impact on book value balance sheet

– Negative equity?

Implementation– Self tender (share repurchase) —Fair?

– Special dividend —Taxes?

If $ 1 billion is good, why not $2, 3, 4 or 5 billion???– When does it stop?

Page 8: “You can’t argue with a river, it is going to flow. You can dam it [or] deflect it, but you can’t argue with it.”— Dean Acheson So it is with Modigliani-

APV Method of Valuation

Before you begin…– Qualitative analysis

» Asymmetries of information, your value added

– Financing—» how many tranches, cost of each, blended rate

APV = Value of all-equity company + PV(ITS)– This is an enterprise value, which gets split between

debt and equity

– Sometimes other terms are added, e.g., cost of environmental cleanup, value of govt subsidies

Page 9: “You can’t argue with a river, it is going to flow. You can dam it [or] deflect it, but you can’t argue with it.”— Dean Acheson So it is with Modigliani-

All-equity enterprise value

From Fin 1– Free cash flows

» EBIAT + DA – Capex – Ch. Net Working Capital

» EBIAT = Earnings before Interest after Tax, so interest payments are included

– Discount rate = Ra from CAPM

– Terminal value» Growing perpetuity model

» Use multiples as a sanity check

Page 10: “You can’t argue with a river, it is going to flow. You can dam it [or] deflect it, but you can’t argue with it.”— Dean Acheson So it is with Modigliani-

Present Value of ITS Cash Flows

– Tax saving (ITS) = Yield (at issue) * Debt * Tax rate– This is a real cash flow: lower tax = more cash

Discount rate is Market Yield (today)– Reasoning is that risk of tax shield is approximately the same as risk of the

related debt– Market yields change as interest rates go up and down, so yields in the

numerator and denominator of the PV(ITS) calculation can be different » if the debt was previously issued and rates have changed

Terminal value—what will happen to debt at the horizon– Grow? Growing perpetuity– Constant? Constant perpetuity– Pay off? Zero

Page 11: “You can’t argue with a river, it is going to flow. You can dam it [or] deflect it, but you can’t argue with it.”— Dean Acheson So it is with Modigliani-

From enterprise to equity value

PV(FCF) incl. PV(TV)

+ PV(ITS) incl. PV(ITS-TV)

– Debt

Equity Value

Private equity firm will earn an equity rate:– Re is higher than Ra (by MM Prop 2)

– Re is much higher than Ra if leverage and beta are high

– We will see this again!

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