Textbook Notes (369,140)
Canada (162,411)
Finance (37)
MGFC10H3 (13)
Derek Chau (13)
Chapter 16

Chapter 16 Notes

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Department
Finance
Course Code
MGFC10H3
Professor
Derek Chau

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Chapter 16 Capital Structure Basic Concepts Notes161 The Capital Structure Question and the Pie Theorypie modelmodel of firms debtequity ratio graphically depicts slices of pie that represent value of firm in capital marketsthe value of the firm V is VBS where B is the market value of the debt and S is the market value of the equityif company managements goal is to make the firm as valuable as possible then the firm should pick the debtequity ratio that makes the piethe total value of the company Vas big as possible163 Financial Leverage and Firm Value An ExampleThe Choice Between Debt and EquityMM Proposition Ia proposition of Modigliani and Miller MM stating that a firm cannot change the total value of its outstanding securities by changing its capital structure proportions also called an irrelevance resultMM Proposition I no taxes the value of the levered firm is the same as the value of the unlevered firm164 Modigliani and Miller Proposition II No TaxesProposition II Required Return to Equityholders Rises with LeverageMM Proposition IIa proposition of MM stating that the cost of equity is a linear function of the firms debtequity ratior0expected earnings to unlevered firmunlevered equityMM Proposition II no taxes rrBS rrS00B165 TaxesValue of the Levered FirmVEBIT1Tr where V is the present value of an unlevered firm EBIT1T is the firm cash flows after UC0UCcorporate taxes T is corporate tax rate and ris the cost of capital to an allequity firmC0 MM Proposition II corporate taxes VEBIT1TrTrBrVTBLC0CBBUCMM Proposition II corporate taxesa proposition of Modigliani and Miller MM stating that by raising the debtequity ratio a firm can lower its taxes and thereby increase its total value capital structure does matterExpected Return and Leverage under Corporate TaxesMM Proposition II corporate taxes rrBS1TrrS0C0BSEBITrB1TrBCSthe numerator is the expected cash flow to
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