【西南财大课件金融经济学】lecture2-Capital_Structure

CapitalStructureSeptember12,2005CorporateFinanceOutlineModigliani&Millerpropositions•Notaxcase•CorporatetaxescaseOthercostsandbenefitsofdebt:•Bankruptcycosts•FCFHypothesis•Signaling&riskshiftingMM&CAPMEmpiricalevidenceCorporateFinanceThecapitalstructureproblemFindingthe“optimalmix”ofsecurities:•Debt,•Equity,•PreferredStocketc.thatmaximisesthevalueofthefirmWefocusontwopolarsecurities:equityanddebtCorporateFinancePropositionIAssuming:•Totalcashflowstosecurityholdersareindependentofhowthefirmisfinanced;•Therearenotransactioncosts,•Noarbitrageopportunitiesexist,Thenthetotalmarketvalueofthefirm(thesumofthevaluesallsourcesofcapital)isindependentofhowthefirmisfinancedCorporateFinanceProofSupposefirmsUandLareidentical,exceptfortheircapitalstructures•U(unlevered)is100%equityfinanced,andisworth800•L(levered)is(partially)financedwithdebt.Ithasazerocouponbondwithafacevalueof600Considertwotimeperiodsonly:t=0(now)andt=1CFatt=1israndom:x{0,600,1000,2000},allequallylikelyCorporateFinanceProofFortheleveredfirm,payoffstoequityanddebtare:xD=xD=600xD=600xD=600xD=0xD=xE=0xE=1400xE=400xE=0CorporateFinanceProofClaim:VU=VL,whereVL=VEL+VDLSupposenot.Then:•StrategyA:Buy50%offirmU•StrategyB:buy50%ofthedebtofLand50%ofitsequityCorporateFinanceProofThetwostrategiesprovideexactlythesamepayoffsNo-arbitrageimpliesthatthepricesofbothstrategiesbethesameCashFlowStrategyAStrategyB0006003003001000500300+20020001000300+700CorporateFinanceProofCostofstrategyA=0.5VU=0.5x800=400CostofstrategyB=0.5VEL+0.5VDL=0.5VLTheymustbeequal(why?):0.5VL=400VL=800Therefore,VL=VUToavoidarbitrage,thetwofirmsmusthavethesamevalue.CorporateFinancePropositionIIUnderthesameassumptions:1)Afirm’scostofcapitaldoesnotdependonitscapitalstructure2)Theexpectedrateofreturnonafirm’sstock(costofequity)increasesinproportiontoitsdebt-equityratioCorporateFinanceMeaningIntuition:•Moredebtdecreasesthecostofcapital(debtischeaper)•But,italsoincreasesthecostofcapital,becauseitincreasestheriskoftheequity•Thetwoeffectsmustcanceleachother(thisisMM)CorporateFinanceProofGivenexpectedcashflows{E(X1),E(X2),…,E(XT)},thefirm’svalueis:(1)BypropositionI,thevalue(V)isindependentofthecapitalstructure,andthereforeofDByassumption,{E(X1),E(X2),…,E(XT)}donotchangewithDeitherTT221)WACC1()X(E...)WACC1()X(EWACC1)X(EVCorporateFinanceProofFrom(1)followsthatthecostofcapital(WACC)cannotdependonD(thisprovespart1)Part2ofthepropositionfollowsfromrewritingtheWACC:))r(EWACC(EDWACC)r(E)r(EEDD)r(EEDEWACCDEDECorporateFinanceAssumptionsThefollowingassumptionsarenecessarytoderivetheresults:•Notransactioncosts(thisisnotsoimportantandcanberelaxed)suchasinformationasymmetriesortaxes»Whichimplythatcashflowsareunaffectedbycapitalstructure(thisisthekeyofthewholething)•No-arbitrage(thisisanon-restrictiveassumption)CorporateFinanceMM,theotherwayaroundMMshowthatunderthoseassumptions,CSisirrelevantButthismeansthatifthoseassumptionsarenotsatisfied,CSisrelevantThewaytolookatCSistolookathowitcanaffecttherealcashflowsthefirmgenerates:•Taxes•Bankruptcycosts•AgencyissuesCorporateFinanceCorporatetaxcaseTaxes•ConsiderafirmwithapermanentdebtlevelD,payingr%peryear•YearlyinterestexpensesarerD,whicharetaxdeductibleundercurrenttaxlawThefirmsavesTCrDintaxeseveryyear,whereTCisthecorporatetaxrate•Ifwediscountthisinperpetuityusingtheinterestrate,DTrrDTPVTSCCCorporateFinanceMMwithtaxes:•Thedifferencebetweentheafter-taxcashflowsofaleveredandanunleveredfirmisthetaxshieldofdebt:TCrDD•ThedifferencebetweenVLandVUisthenthepresentvalueofthefuturetaxshields:VL=VU+PVTS•Ifdebtisconstant(perpetuity)thisreducesto:VL=VU+TCDCorporateFinanceCostsofDebt:BankruptcycostsSofaronlybenefitsofdebt•Firmsthoughdon’thaveall-debtfinancialstructuresTheremustbecostsofdebtThemaincostofdebtistheprobabilityoffinancialdistressFD:situationwhereafirmcannotsatisfyitscurrentobligationsCorporateFinanceDirectCostsofFDAfirminfinancialdistress:•Renegotiatetheclaims•Forceliquidation(Chapter7inUS)•Reorganiseoperations(Ch11,uitstelvanbetaling)Directcostsare:•Legalexpenses,lawyersetc•IntheUS,amountto1-3%offirm’sexantevalueCorporateFinanceIndirectCostsofFDDirectcostsdon’tseemtobesignificantenough(1%ofmarketvalue)Theremustbethusothercosts:•Employeemotivation•Customerlossofconfidence•Creditconstraints(andforgoingofpositiveNPVinvestments)•Debtholder-equityholderconflictsCorporateFinanceThe“statictrade-offtheory”Combiningthetaxshieldeffectwiththebankuptcycosts,VL=VU+TCD–BCLeverage$D*TaxespaidCostsofFDCorporateFinanceOtherbenefitsofdebt:FCFHypothesisJensen(1986)(page766)Example:•ArmandHammer(OccidentalPetroleum)spend$120minanartmuseum•Whyshareholdersallowthis?FCFdefinition(here):fundsavailableformanagemenetafterfinancingallprojectswithNPV0Thesefundsshouldbepaidout(otherwisearelikelytobeinvestedinnegativeNPVprojects)Howcanmanagementcommittoindeedpayout?Debtisasolution:itforcesmanagementtopayinterestandrepayprincipalCorporateFinanceSignalingtheoriesSupposefirmsaredividedintotwogroups,goodandbadfirmsIfabadfirmincreasesdebtaboveace