Fundamentals of Corporate Finance Third edition Chapter 15 The Capital Brealey Myers Marcus Structure Decision ndamentals of Corporate Finan Brealey Myers Marcus slides by Matthew will IrwinMcGraw-Hill CThe McGraw-Hill Companies, Inc, 2001
©The McGraw-Hill Companies, Inc.,2001 15- 1 Irwin/McGraw-Hill Chapter 15 Fundamentals of Corporate Finance Third Edition The Capital Structure Decision Brealey Myers Marcus slides by Matthew Will Irwin/McGraw-Hill ©The McGraw-Hill Companies, Inc.,2001
15-2 Topics Covered O Debt and Value in a Tax Free Economy CApital Structure and Corporate Taxes SCost of financial distress EXplaining financial choices Irwin/McGraw-Hill CThe McGraw-Hill Commpanies, Inc, 2001
©The McGraw-Hill Companies, Inc.,2001 15- 2 Irwin/McGraw-Hill Topics Covered Debt and Value in a Tax Free Economy Capital Structure and Corporate Taxes Cost of Financial Distress Explaining Financial Choices
15-3 M&M(debt Policy Doesnt Matter) MOdigliani miller When there are no taxes and capital markets function well. it makes no difference whether the firm borrows or individual shareholders borrow. Therefore the market value of a company does not depend on its capital structure Irwin/McGraw-Hill CThe McGraw-Hill Commpanies, Inc, 2001
©The McGraw-Hill Companies, Inc.,2001 15- 3 Irwin/McGraw-Hill M&M (Debt Policy Doesn’t Matter) Modigliani & Miller ➔When there are no taxes and capital markets function well, it makes no difference whether the firm borrows or individual shareholders borrow. Therefore, the market value of a company does not depend on its capital structure
15-4 M&M(debt Policy Doesnt Matter) Assumptions O By issuing 1 security rather than 2,company diminishes investor choice. This does not reduce value if Investors do not need choice OR There are sufficient alternative securities S Capital structure does not affect cash flows e.g → No taxes → no bankruptcy costs )No effect on management incentives Irwin/McGraw-Hill CThe McGraw-Hill Commpanies, Inc, 2001
©The McGraw-Hill Companies, Inc.,2001 15- 4 Irwin/McGraw-Hill M&M (Debt Policy Doesn’t Matter) Assumptions By issuing 1 security rather than 2, company diminishes investor choice. This does not reduce value if: ➔ Investors do not need choice, OR ➔ There are sufficient alternative securities Capital structure does not affect cash flows e.g... ➔No taxes ➔No bankruptcy costs ➔No effect on management incentives
15-5 M&M (Debt Policy Doesnt Matter) Example- River Cruises- All Equity financed Data Number of shares 100000 Price per share $10 m="""〓〓〓〓〓 Market Value of Shares S 1 million Outcome State of the economy Slump Expected Boom Operating Income $75,000125000175,000 Earnings per share $ 75 1.25 175 Return on shares 7.5 12.5% 17.5 Irwin/McGraw-Hill CThe McGraw-Hill Commpanies, Inc, 2001
©The McGraw-Hill Companies, Inc.,2001 15- 5 Irwin/McGraw-Hill Example - River Cruises - All Equity Financed Return on shares 7.5% 12.5% 17.5% Earnings per share $.75 1.25 1.75 Operating Income $75,000 125,000 175,000 Slump Expected Boom Outcome State of the Economy Market Value of Shares $1million Price per share $10 Number of shares 100,000 Data M&M (Debt Policy Doesn’t Matter)