You are on page 1of 2

Chapter 11 Chapter 18: Debt & Taxes

Term Debt Example Perpetual Debt Example

After-Tax WACC is Lower Recap w/ Tax Shield The Three Steps

Chapter 17 – Leverage, Arbitrage, and Firm Value


MM1 & The Law of One Price Market Value Balance Sheet Levered Recapitalization

Pre-Tax WACC After-Tax WACC

Recapitalization
MM2: Convert this formula to returns (weighted cost of capital)

Chapter 19: The Tradeoff Model of Capital Structure


Financial Distress: When a firm has difficulty meeting financial obligations (risk of bankruptcy is likely)
Default: When a firm fails to make the required interest or principal payments on its debt
| |
No Friction Example MM1 still holds without taxes Friction Costs:

Direct Costs: Lawyers,


Accountants,
Consultants
Indirect Costs: Loss of
customers, supplies, fire
sale of assets

Same Example with Cost of Distress -> VL = VU + PV (Interest Tax Shield) – PV (Financial Distress Costs)
Tradeoff Theory: Finding
Optimal Point on the
Capital Structure
Spectrum
Chapter 21: Valuation and Leverage Chapter 10: CAPM = Security Market Line -> visual representation of CAPM model (MRP=slope) etc.

using the WACC


discounting the free cash flows of the investment
3) Compute the value with leverage VL, by
benefit
2) Compute WACC using formula that includes tax
1) Determine the unlevered FCF of the investment
WACC Method: Free Cash Flows

Discount FCF using the WACC Maintaining Target D/E Ratio

Adjusted Present Value Method (APV):

Chapter 13:
Difference between E[R] and rs is known as alpha
U
1) Determine investment’s value without leverage, V , by
discounting its FCFs at unlevered cost of capita, r U
2) Determine then discount to get PV(ITS). If constant
debt-equity ratio, use rU
3) Add the unlevered value, VU, to the PV of the interest
tax shield to determine the value of the investment with
leverage, VL

Chapter 12: Estimating Project Cost of Capital


Value Weighted Portfolio CAPM

Debt Cost of Capital: Yield to Maturity is NOT RD Example

Yield to Maturity Example Solution

Projects Cost of Capital – Two Methods

You might also like