ECON 2560 Chapter Notes - Chapter 16: Capital Structure, Tax Shield, Dividend Yield

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maroonmoose340

24 Jul 2014

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Mm"s prosposition i: how borrowing affects risk and return o, restructuring does not affect operating incomes, regardless of the state of the economy, debt financing doesn"t affect the oeprating risk or the business riskk of the firm. 1. 25/10 = . 125: this is the cost of equity capital, requity and also r assets, overall return = (rdebt * d/v) + (requity * e/v) o o. If the debt is permanent, then the firm can look forward to an annual savings of in perpetuity: their present value is = 17500/. 1 o o, how interest tax shields contribute to the value of. Shareholders equity: in a no tax world, mm"s proposition i states that the value of the firm is unaffected by capital structure, mm also modified proposition i to recognize corporate taxes. Value of levered firm = value if all equity financed + present value of tax shield: in the special case of permanent debt.

Related Questions

d. TTC recently introduced a new line of products that has been wildly successful. On the basis of this

success and anticipated future success, the following free cash flows were projected:

After the 10th year, TTC's financial planners anticipate that its free cash flow will grow at a constant rate

of 6%. Also, the firm concluded that the new product caused the WACC to fall to 9%. The market value

of TTC's debt is $1,200 million, it uses no preferred stock, and there are 20 million shares of common

stock outstanding. Use the corporate valuation model approach to value the stock.

INPUT DATA: (Dollars in Millions)

g_n

PV of FCF_1-10 =

HV at Year 10 of FCF after Year 10 = FCF₁₁/(WACC â g_n):

PV of HV at Year 0 = HV/(1+WACC)¹⁰:

Sum = Value of the Total Corporation

Less: MV of Debt and Preferred

Value of Common Equity

Number of Shares (in Millions) to Divide By:

Value per Share = Value of Common Equity/No. Shares:

versus

using the discounted

dividend model

The price as estimated by the corporate valuation method differs from the discounted dividends method because

different assumptions are built into the two situations. If we had projected financial statements, found both

dividends and free cash flow from those projected statements, and applied the two methods, then the

prices produced would have been identical. As it stands, though, the two prices were based on somewhat

different assumptions, hence different prices were obtained. Note especially that in the FCF model we

assumed a WACC of 9% versus a cost of equity of 10% for the discounted dividend model. That would obviously tend to

raise the price.

aquamarineprairie-dog413

In the short run, a tighter monetary policy by the U.S. Federal Reserve leads to:

Select one:

a. an increase in the supply of dollars and a dollar depreciation.

b. a decrease in the supply of dollars and a dollar appreciation.

c. an increase in the demand for dollars and a dollar depreciation.

d. a decrease in the demand for dollars and a dollar appreciation.

Which theorem states that exchange rates will adjust until the prices of goods in different countries approximate one another?

Select one:

a. purchasing power parity

b. the law of multiple prices

c. the principle of comparative advantage

d. dollarization

A country's balance of trade is the difference between its:

Select one:

a. nominal and real exchange rates.

b. monetary and fiscal policy.

c. exports and imports.

d. capital inflow and capital outflow.

When a foreign business buys stock in a U.S. company, the U.S. capital account will:

Select one:

a. move in a positive direction.

b. move in a negative direction.

c. remain unchanged.

d. become more volatile.

Saying that the United States is running a large current account deficit is equivalent to saying that:

Select one:

a. exports exceed imports in the United States.

b. the United States is running a large capital account surplus.

c. the balance of payments is negative.

d. the value of the current capital stock in the United States exceeds the value of future capital flows.

10-

An increase in the demand for a country's exports will have what effect on its currency?

Select one:

a. Its value will not change.

b. Its value will increase.

c. Its value will decrease.

d. Its value will depreciate.

11-

When the United States has a current account deficit, the U.S. capital account:

Select one:

a. will have a deficit also.

b. will be balanced.

c. will have a surplus.

d. must be falling.

12-

Which of the following is NOT a way that a country can finance a trade deficit?

Select one:

a. increased borrowing

b. sale of assets

c. decreased exports

d. reduction in cash reserves

13-

A trade deficit occurs when the value of a country's:

Select one:

a. imports exceeds the value of its exports.

b. exports exceeds the value of its imports.

c. inflow of foreign capital exceeds the outflow of domestic capital.

d. outflow of domestic capital exceeds its inflow of foreign capital.

14-

Which of the following is a U.S. current account transaction?

Select one:

a. Selling a computer chip to a resident in Europe.

b. Buying stock shares of a Canadian company.

c. Selling U.S. dollars in exchange for euros.

d. A foreign investor's purchase of a manufacturing plant in the United States.

15-

An exchange rate is:

Select one:

a. a yearly summary of all the economic transactions between residents of one country and residents of the rest of the world.

b. the sum of the balance of trade, net income on capital held abroad, and net transfer payments.

c. the price of one currency in terms of another currency.

d. a currency whose value is not pegged but governments will intervene extensively in the market to keep the value within a certain range.

amethysthedgehog627

True or False

Since no one party owns a not-for-profit hospital, physicians really own the hospitalâs business.

The value of any capital project can be assessed by estimating expected future cash flows from the project and discounting them to the present value. This procedure accounts for the time value of money.

Consumer cooperatives have a long and successful history in development of the HMO.

For-profit firms make up the bulk of hospital organizations.

Kaiser Health Plan is the only HMO in the U.S. to consistently maintain its core competencies. That is, it has kept client satisfaction high, while keeping the growth rate of premiums higher than the growth rate of medical costs.

When Allegheny Hospital System (AHERF) went bankrupt, the price of borrowing for all hospitals increased. This is an example of correlated system risk.

It could be argued that the federal and state governments provide an implicit guarantee of hospital borrowings because revenue from Medicare and Medicaid patients is assumed to be guaranteed.

Venture capitalists are entrepreneurs who specialize in high-risk investments. Often they are the only available source of financing for small startup biotech companies, which very rarely are able to obtain bank loans to finance their research.

One of the most important things an HMO should do to stay profitable is to make sure a) the medical costsâ rate of growth is below the rate of growth of premiums (revenues), and b) customer satisfaction does not slip.

Research studies indicate that when a non-profit healthcare organization is converted to a for-profit status, it might lead to higher prices and a reduction in the number of services offered, if the converting organization had significant monopolistic market power in that geographical area.

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ECON 2560 Chapter Notes - Chapter 16: Capital Structure, Tax Shield, Dividend Yield

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