MM and the Real World
In perfect capital markets,MM made it clear thatfirm value and the average cost of capital are independent of thefirm’s capital structure.Why MM results are important if,after all,capital markets are not perfect in the real world. While it is true that capital markets are not prefect,all scientific theories begin with a t of idealized assumptions from which conclusions can be drawn. When we apply the theory,we must then evaluate how cloly the assumptions hold,and consider the conquences of any important deviations.
Recall that the a perfect market exists under the following assumptions: Investors andfirms can trade the same t of curities at competitive
market prices equal to the prent value of their future cashflows.
There are no taxes,transaction costs,or issuance costs associated with
curity trading.
Afirm’sfinancing decisions do not change the cashflows generated by its investments,nor do they reveal new information about them.
Thus,we must look to market imperfections to explain why capital structure matters in the real world.
Corporations pay taxes on their profits after interest payments are deducted. Thus,interest expen reduces the amount of corporate taxes.This creates an incentive to u debt.
Consider an unleveredfirm,U.Its after-tax cashflows to all its , equity holders)are given by
EBIT−τ×EBIT
Consider a leveredfirm,L.Its after-tax cashflows to all its ,
equity holders and debt holders)are given by
EBIT−τ×(EBIT−Interest Payment)
The gain to investors of the leveredfirm is given by
三年级口算乘法τ×Interest Payment,
and it results from the tax deductibility of interest payments and is referred to
as the interest tax shield.
11.2012327
Valuing the Interest Tax Shield
When afirm us debt,the interest tax shield provides a corporate tax benefit each year.
This benefit is the computed as the prent value of the stream of future interest tax shields thefirm will receive.
The cashflows a leveredfirm pays to investors will be higher than they would
be without leverage by the amount of the interest tax shield.
Cash Flows to Investors
with Leverage鸣虫
=
Cash Flows to Investors
without Leverage
+(Interest Tax Shield)
The MM Proposition I
未来的我The total value of the leveredfirm exceeds the value of thefirm without leverage due to the prent value of the tax savings from debt.
V L=V U+PV(Interest Tax Shield)
The above calculation assumes the debt is risk free and the risk-free interest
rate is constant.However,the assumptions are unnecessary.
If the debt is fairly priced,no arbitrage implies that its market value must
equal the prent value of the future interest payments.
高收入Market Value of Debt=D=PV(Future Interest Payments)
If thefirm’s marginal tax rate is constant,then:
PV(Interest Tax Shield)=PV(τc×Future Interest Payments)
=τc×PV(Future Interest Payments)
=τc×D
11.2012727
The WACC with and without Corporate Taxes
Finance(SHUFE)Lec11.Capital Structure(II)Spring20129/27
散台Example:Recapitalizing to Capture the Tax Shield
Assume that Midco Industries wants to boost its stock price.The company currently has20million shares outstanding with a market price of$15per
share and no debt.Midco has had consistently stable earnings,and pays a
35%tax rate.Management plans to borrow$100million on a permanent basis and they will u the borrowed funds to repurcha outstanding shares.
角巾Without leverage
V U=20×15=300million
If Midco borrows$100million using permanent debt,the prent value of the
firm’s future tax savings is
PV(Interest Tax Shield)=τc×D=0.35×100=35million
话题英文Thus the total value of the leveredfirm will be
V L=V U+τc D=300+35=335million
with debt worth100and equity worth235million.
生孩子朋友圈
