Corporate Borrowing and Leverage Effects
|
|
- Annabelle Spencer
- 5 years ago
- Views:
Transcription
1 FIN 614 Mixing Debt and Equity Professor Robert B.H. Hauswald Kogod School of Business, AU Corporate Borrowing and Leverage Effects Continue with deviations from ideal world of M&M taxes, financial and operating risks, etc. Homemade leverage - investors can create or adjust leverage how they see fit suppose the firm does not change its capital structure but investors want high debt: continue our example management might prefer low debt: why? Leverage mitigates and exacerbates conflicts of interests within the firm in the absence of full information managers vs. owners: mitigates managerial agency conflicts shareholders vs. debtholders: creates debt agency conflicts 3/22/2011 Debt and Equity Robert B.H. Hauswald 2
2 Operating Leverage The degree of operating leverage measures how sensitive a firm (or project) is to its fixed costs. Operating leverage increases as fixed costs rise and variable costs fall. Operating leverage magnifies the effect of cyclicity on beta. The degree of operating leverage is given by: DOL = EBIT EBIT Sales Sales 3/22/2011 Debt and Equity Robert B.H. Hauswald 3 Operating Leverage $ Total costs EBIT Fixed costs Volume Fixed costs Volume Operating leverage increases as fixed costs rise and variable costs fall. 3/22/2011 Debt and Equity Robert B.H. Hauswald 4
3 Consequences of Operating Leverage Degree of operating leverage: sensitivity of operating cash flow to a percentage change in Q (quantity) Percentage change in OCF = DOL x percentage change in Q so that DOL = 1 + FC/OCF Selection of high risk projects: risk may increase with debt ratio gambling for resurrection: limited liability invites risk shifting ==> "go for broke since you will get nothing otherwise" A project can have a positive NPV for one group of claimants (investors), while its overall NPV is negative Examples: Hunt Brothers, S&Ls (Charles Keating) 3/22/2011 Debt and Equity Robert B.H. Hauswald 5 Financial Slack Amount of funds available for investment without external finance after paying interest essentially the amount of retentions before paying dividends + depreciation: cash at hand More equity (financial slack) or more debt? 2 factors likelihood of finding and exploiting good investment opportunities 1. Firm s track record: lemons problem firms may be willing to take risks and negative NPV projects because they are investing other peoples money 2. Financing available for good opportunities? small growing firms may have problems raising financing when they have positive NPV projects: convincing investors about projects merit out of a pool of potential investments 3/22/2011 Debt and Equity Robert B.H. Hauswald 6
4 Costs of Financial Slack: Managerial Agency Conflicts 1. Conflicts between managers and shareholders: uneconomic expansion: empire building, dotcoms, ATT-NCR debt can be a mechanism that "ties the manager's hands" 2. Conflicts between shareholders, managers and employees: high debt can also be a mechanism that reduces the pool of profits that labor can bargain over facilitates adjustment to a new economic environment helps managers avoid emotionally costly decisions reduces over-diversification: to protect themselves against bankruptcy managers might over-diversify (human capital) possible reversal of this trend: 1980s Focus on Core Competencies and debt reduction 3/22/2011 Debt and Equity Robert B.H. Hauswald 7 Asset Type Asset type is one of the most important factors in capital structure design determining differential growth opportunities, and differential agency costs, and differential information Example: Back to the Future old economy: assets in place might inhibit the exercise of growth opportunities new economy: assets are mainly human capital (technology, processes, ideas) and need incentives 3/22/2011 Debt and Equity Robert B.H. Hauswald 8
5 Asset Type and Debt-Equity Mix Factors arguing for more equity: human assets growth opportunities combined with differential information financial distress costs: higher for firms with intangible assets or assets that are hard to sell Factors favoring more debt: taxes and agency conflicts tax advantages: firms with stable cash flows will be able to use the tax advantages of debt (even tax credits) stable firms with high free cash flow from current operations without profitable investment opportunities will tend to increase debt - thus avoiding over-investment signalling: high debt may signal good stable opportunities 3/22/2011 Debt and Equity Robert B.H. Hauswald 9 The Store(s) around the Corner Two individuals want to open and operate a corner grocery store without sufficient funds: need $100,000 they must finance the store by raising money (external finance) Kelly finances the store with EQUITY sells 90% of the business to an investor for 90,000 Tom finances his store with DEBT 100% ownership, finances 90% of the store with a 90,000 loan By JUNE it becomes apparent that both stores have made 90,000. summer profit opportunities are 10,000: work is tough and it takes 2,500 to get owners to forego the beach who works, and who goes to the beach? 3/22/2011 Debt and Equity Robert B.H. Hauswald 10
6 Increased Effort and Incentives Tom knows that he will get all $10,000 of the PROFIT so he stays and works can you show this? Kelly realizes that she will only get $1,000 of the $10,000 so goes to the BEACH ==>Debt can produce higher efficiency and less waste: reduction in agency costs Other examples: desire to buy jet planes or other firms a fancy office costs $50,000 but adds only $25,000 to corporate profits: Tom would not buy! Kelly gets $25,000 of benefits but only costs her $5,000 of her money: Kelly installs the fancy office 3/22/2011 Debt and Equity Robert B.H. Hauswald 11 Cost of (too much) Debt: Debt Agency Conflict of interest between manager-shareholders and debtholders (banks, bondholders) risk-shifting: take risks that are beneficial to owners Examples: take bad risks Incentive to take large risks: gambling for resurrection Incentive toward underinvestment: fly to Rio Milking the property: asset stripping Consequences: shift costs to debtholders Impaired ability to conduct business (e.g., lost sales) Agency Costs 3/22/2011 Debt and Equity Robert B.H. Hauswald 12
7 Balance Sheet for a Company in Financial Distress Assets BV MV Liabilities BV MV Cash $200 $200 LT bonds $300 $200 Fixed Asset $400 $0 Equity $300 Total $600 $200 Total $600 $200 $0 What happens if the firm is liquidated today? Bondholders get $200; shareholders get nothing! 3/22/2011 Debt and Equity Robert B.H. Hauswald 13 Self-interested Owners 1: Gambling for Resurrection R&D Gamble Probability Payoff Win Big 10% $1,000 Lose Big 90% $0 Cost of investment is $200 (all the firm s cash) Required return is 50% Expected CF from the Gamble = $ $0 = $100 NPV = $200 + $100 (1.50) NPV = $133 3/22/2011 Debt and Equity Robert B.H. Hauswald 14
8 Negative NPV Project Selection Expected CF from the R&D Gamble To Bondholders = $ $0 = $30 To Stockholders = ($1000 $300) $0 = $70 PV of Bonds Without the Gamble = $200 PV of Stocks Without the Gamble = $0 PV of Bonds With the Gamble: PV of Stocks With the Gamble: $20 = $30 (1.50) $47 = $70 (1.50) 3/22/2011 Debt and Equity Robert B.H. Hauswald 15 Self-interested Owners 2: Underinvestment Continue previous example of firm in distress but consider a government-sponsored project that guarantees $350 in one period: sure return with same balance sheet Cost of investment is $300 the firm only has $200 in cash so that stockholders will have to supply an additional $100 to finance the project Required return is 10% $350 NPV = $ = $ Accept or reject project? 3/22/2011 Debt and Equity Robert B.H. Hauswald 16
9 Selfish Shareholders Forego Positive NPV Project Expected CF from the government sponsored project: to bondholders = $300 to shareholders = ($350 $300) = $50 PV of Bonds Without the Project = $200 PV of Stocks Without the Project = $0 PV of Bonds With the Project: $ = $300 (1.10) $50 PV of Stocks With the Project: - $54.55 = $100 (1.10) 3/22/2011 Debt and Equity Robert B.H. Hauswald 17 Self-interested Owners 3: Milking the Property Liquidating dividends: suppose our firm paid out a $200 dividend to the shareholders. payment leaves the firm insolvent, with nothing for the bondholders, but plenty for the former shareholders Such actions often violate bond indentures PG&E however used such extraordinary dividend payments to drive generating subsidiary into bankruptcy Equivalent strategies just increase perquisites to shareholders and/or management free products, housing, jets, etc. 3/22/2011 Debt and Equity Robert B.H. Hauswald 18
10 Costs of Financial Distress E[Costs] = Prob. of bankruptcy * Cost of Bankruptcy Direct costs: lawyers, accountants, consultants dividing up/redistributing the pie: enforcement costs generally thought to be small (Warner 1977: Journal of Financial Economics) but in some cases not: Eastern Airlines taxes: loss of PV of tax credits Indirect costs: matter most sales and customers (reliability): costs of switching suppliers, lost up-front relationship specific costs opportunities: cutback in R&D, advertising; higher charges operating costs: higher costs of labor or of investing in long term relationship flexibility: debt restrictions and covenants 3/22/2011 Debt and Equity Robert B.H. Hauswald 19 Forms of Increased Leverage All debt instruments: private and public debt, loans Debt securities: bonds rated by Moody s and S&P investment grade: rated at least Baa (Moody s) or BBB (S&P) high yield: bonds rated lower than investment grade (junk) Why do some borrowers have to pay a higher interest rate than others? caveat emptor! borrowers demand risk premium: promised vs. effective yield Promised yield (to maturity): ytm that is calculated assuming NO default risk Effective yield (to maturity): ytm that takes into account the bonds expected payments, i.e., incorporate default risk 3/22/2011 Debt and Equity Robert B.H. Hauswald 20
11 Pricing Default Risk (Default) risk free bonds have a 9% coupon, $1,000 par (face) value, 1 year to maturity Suppose a company has a 20% chance of default issues 1 year note at 9% bondholders receive nothing in the event of default they receive full payment + interest otherwise. Assume that default is not correlated with systematic market risk: bonds β = 0 What are the effective and promised yields? bondholders rationally anticipate on shareholder actions and price bond accordingly self-interested actions affect borrowing costs 3/22/2011 Debt and Equity Robert B.H. Hauswald 21 Solution Outcome Payoff Probability Full Payment $ No Payment $0 0.2 Expected Value of the Payment = 0.8 ($1,090) ($0) = $872 Note that investors require only 9% by assumption: no correlation with systematic risk PV of the bonds = $872 / 1.09 = $800 An investor who bought the notes at this price would receive a promised yield of: Promised yield: still 9% Effective yield: 1,090 y = 1 = 36.25% 800 3/22/2011 Debt and Equity Robert B.H. Hauswald 22
12 The Firm as a Pie Revisited Taxes and bankruptcy costs can be viewed as just another claim on the cash flows of the firm. Let G and L stand for payments to the government and bankruptcy lawyers, respectively. V T = S + B + G + L B S L G The essence of the M&M intuition is that V T depends on the cash flow of the firm; capital structure just slices the pie. 3/22/2011 Debt and Equity Robert B.H. Hauswald 23 Capital Structure Design Maximum firm value Value of firm (V) Present value of tax shield on debt Present value of financial distress costs V L = V U + T C B Value of firm under MM with corporate taxes and debt V L < V U + T C B when T S < T B but (1-T B ) > (1-T C ) (1-T S ) V U = Value of firm with no debt V = Actual value of firm with bankruptcy costs Agency Cost of Equity Agency Cost of Debt 0 Debt (B) B* 3/22/2011 Debt and Equity Robert B.H. Hauswald 24
13 Summary and Conclusion Optimal capital structure trade off costs and benefits Advantages to debt: reduction of taxes through tax shield reduces managerial discretion when firm has few positive investment opportunities Disadvantages of debt: bankruptcy costs may be significant and affect operations Advantages of equity: increased managerial discretion when firm has more positive investment opportunities and outside investors have poor ability to choose good firms 3/22/2011 Debt and Equity Robert B.H. Hauswald 25 Appendix: Industry D/E Ratios 3/22/2011 Debt and Equity Robert B.H. Hauswald 26
14 Market Default Risk Let default be related to the market: more likely to occur in a recession: investors will require an additional bond risk-premium Suppose the required premium is 2%: β = 0.25 R d = R f + β ( Ε(r m ) - R f ): the market risk premium is 8% ==> R d = 9% +.25( 8%) = 11% The notes will sell for: 872/ 1.11 = risk-adjusted yield: discounting expected value both numerator and denominator adjusted for risk! Effective yield: $1090 / = 38.8% Promised yield? 3/22/2011 Debt and Equity Robert B.H. Hauswald 27
Financial Distress Costs and Firm Value
1 2 I. Limits to Use of Debt According to MM Propositions with corporate taxes, firms should have a capital structure almost entirely composed of debt. Does it make sense in the real world? Why? Note 14
More informationOptions in Corporate Finance
FIN 614 Corporate Applications of Option Theory Professor Robert B.H. Hauswald Kogod School of Business, AU Options in Corporate Finance The value of financial and managerial flexibility: everybody values
More informationHomework Solution Ch15
FIN 302 Homework Solution Ch15 Chapter 15: Debt Policy 1. a. True. b. False. As financial leverage increases, the expected rate of return on equity rises by just enough to compensate for its higher risk.
More informationCapital Structure. Capital Structure. Konan Chan. Corporate Finance, Leverage effect Capital structure stories. Capital structure patterns
Capital Structure, 2018 Konan Chan Capital Structure Leverage effect Capital structure stories MM theory Trade-off theory Free cash flow theory Pecking order theory Market timing Capital structure patterns
More informationPrinciples of Corporate Finance
Principles of Corporate Finance Chapter 19. How much should a firm borrow? Ciclo Profissional 2 o Semestre / 2009 Graduacão em Ciências Econômicas V. Filipe Martins-da-Rocha (FGV) Principles of Corporate
More informationCorporate Finance. Dr Cesario MATEUS Session
Corporate Finance Dr Cesario MATEUS cesariomateus@gmail.com www.cesariomateus.com Session 4 26.03.2014 The Capital Structure Decision 2 Maximizing Firm value vs. Maximizing Shareholder Interests If the
More informationRISK MANAGEMENT AND VALUE CREATION
RISK MANAGEMENT AND VALUE CREATION Risk Management and Value Creation On perfect capital market, risk management is irrelevant (M&M). No taxes No bankruptcy costs No information asymmetries No agency problems
More informationMaximizing the value of the firm is the goal of managing capital structure.
Key Concepts and Skills Understand the effect of financial leverage on cash flows and the cost of equity Understand the impact of taxes and bankruptcy on capital structure choice Understand the basic components
More informationLet s Build a Capital Structure
FIN 614 Capital tructure Design Principles Professor Robert.H. Hauswald Kogod chool of usiness, AU Let s uild a Capital tructure Determinants of firms debt-equity mix operations funded with a combination
More informationChapter 16 Debt Policy
Chapter 16 Debt Policy Konan Chan Financial Management, Fall 2018 Topic Covered Capital structure decision Leverage effect Capital structure theory MM (no taxes) MM (with taxes) Trade-off Pecking order
More informationCapital structure I: Basic Concepts
Capital structure I: Basic Concepts What is a capital structure? The big question: How should the firm finance its investments? The methods the firm uses to finance its investments is called its capital
More information: Corporate Finance. Financing Projects
380.760: Corporate Finance Lecture 7: Capital Structure Professor Gordon M. Bodnar 2009 Gordon Bodnar, 2009 Financing Projects The capital structure decision the choice of securities a entrepreneur uses
More informationEMP 62 Corporate Finance
Kellogg EMP 62 Corporate Finance Capital Structure 1 Today s Agenda Introduce the effect of debt on firm value in a basic model Consider the effect of taxes on capital structure, firm valuation, and the
More informationChapter 15. Topics in Chapter. Capital Structure Decisions
Chapter 15 Capital Structure Decisions 1 Topics in Chapter Overview and preview of capital structure effects Business versus financial risk The impact of debt on returns Capital structure theory, evidence,
More informationCapital Structure. Finance 100
Capital Structure Finance 100 Prof. Michael R. Roberts 1 Topic Overview Capital structure in perfect capital markets» M&M I and II Capital structure with imperfect capital markets» Taxes Optimal Capital
More informationOPTIMAL CAPITAL STRUCTURE & CAPITAL BUDGETING WITH TAXES
OPTIMAL CAPITAL STRUCTURE & CAPITAL BUDGETING WITH TAXES Topics: Consider Modigliani & Miller s insights into optimal capital structure Without corporate taxes è Financing policy is irrelevant With corporate
More informationAdvanced Corporate Finance. 3. Capital structure
Advanced Corporate Finance 3. Capital structure Objectives of the session So far, NPV concept and possibility to move from accounting data to cash flows => But necessity to go further regarding the discount
More informationDebt. Firm s assets. Common Equity
Debt/Equity Definition The mix of securities that a firm uses to finance its investments is called its capital structure. The two most important such securities are debt and equity Debt Firm s assets Common
More informationFCF t. V = t=1. Topics in Chapter. Chapter 16. How can capital structure affect value? Basic Definitions. (1 + WACC) t
Topics in Chapter Chapter 16 Capital Structure Decisions Overview and preview of capital structure effects Business versus financial risk The impact of debt on returns Capital structure theory, evidence,
More informationChapter 16: Financial Distress, Managerial Incentives, and Information
Chapter 16: Financial Distress, Managerial Incentives, and Information-1 Chapter 16: Financial Distress, Managerial Incentives, and Information I. Basic Ideas 1. As debt increases, chance of bankruptcy
More informationCHAPTER 16 CAPITAL STRUCTURE: BASIC CONCEPTS
CHAPTER 16 CAPITAL STRUCTURE: BASIC CONCEPTS Answers to Concepts Review and Critical Thinking Questions 2. False. A reduction in leverage will decrease both the risk of the stock and its expected return.
More informationCorporate Financial Management. Lecture 3: Other explanations of capital structure
Corporate Financial Management Lecture 3: Other explanations of capital structure As we discussed in previous lectures, two extreme results, namely the irrelevance of capital structure and 100 percent
More informationDisclaimer: This resource package is for studying purposes only EDUCATION
Disclaimer: This resource package is for studying purposes only EDUCATION Chapter 6: Valuing stocks Bond Cash Flows, Prices, and Yields - Maturity date: Final payment date - Term: Time remaining until
More informationAFM 371 Practice Problem Set #2 Winter Suggested Solutions
AFM 371 Practice Problem Set #2 Winter 2008 Suggested Solutions 1. Text Problems: 16.2 (a) The debt-equity ratio is the market value of debt divided by the market value of equity. In this case we have
More informationQuestion # 4 of 15 ( Start time: 07:07:31 PM )
MGT 201 - Financial Management (Quiz # 5) 400+ Quizzes solved by Muhammad Afaaq Afaaq_tariq@yahoo.com Date Monday 31st January and Tuesday 1st February 2011 Question # 1 of 15 ( Start time: 07:04:34 PM
More informationCapital Structure, cont. Katharina Lewellen Finance Theory II March 5, 2003
Capital Structure, cont. Katharina Lewellen Finance Theory II March 5, 2003 Target Capital Structure Approach 1. Start with M-M Irrelevance 2. Add two ingredients that change the size of the pie. Taxes
More informationFINALTERM EXAMINATION Spring 2009 MGT201- Financial Management (Session - 2) Question No: 1 ( Marks: 1 ) - Please choose one What is the long-run objective of financial management? Maximize earnings per
More informationAdvanced Risk Management
Winter 2015/2016 Advanced Risk Management Part I: Decision Theory and Risk Management Motives Lecture 4: Risk Management Motives Perfect financial markets Assumptions: no taxes no transaction costs no
More informationQuestion # 1 of 15 ( Start time: 01:53:35 PM ) Total Marks: 1
MGT 201 - Financial Management (Quiz # 5) 380+ Quizzes solved by Muhammad Afaaq Afaaq_tariq@yahoo.com Date Monday 31st January and Tuesday 1st February 2011 Question # 1 of 15 ( Start time: 01:53:35 PM
More informationBasic Finance Exam #2
Basic Finance Exam #2 Chapter 10: Capital Budget list of planned investment project Sensitivity Analysis analysis of the effects on project profitability of changes in sales, costs and so on Fixed Cost
More information: Corporate Finance. Corporate Decisions
380.760: Corporate Finance Lecture 6: Corporate Financing Professor Gordon M. Bodnar 2009 Gordon Bodnar, 2009 Corporate Decisions Investment decision vs. financing decision until now we have focused on
More information600 Solved MCQs of MGT201 BY
600 Solved MCQs of MGT201 BY http://vustudents.ning.com Why companies invest in projects with negative NPV? Because there is hidden value in each project Because there may be chance of rapid growth Because
More informationFinancial Leverage: the extent to which a company is committed to fixed charges related to interest payments. Measured by:
Wk 11 FINS1613 Notes 13.1 Discuss the effect of Financial Leverage Financial Leverage: the extent to which a company is committed to fixed charges related to interest payments. Measured by: The debt to
More informationMGT411 Money & Banking Latest Solved Quizzes By
MGT411 Money & Banking Latest Solved Quizzes By http://vustudents.ning.com Which of the following is true of a nation's central bank? It makes important decisions about the nation's tax and public spending
More informationI. Introduction to Bonds
University of California, Merced ECO 163-Economics of Investments Chapter 10 Lecture otes I. Introduction to Bonds Professor Jason Lee A. Definitions Definition: A bond obligates the issuer to make specified
More informationChapter 3: Debt financing. Albert Banal-Estanol
Corporate Finance Chapter 3: Debt financing Albert Banal-Estanol Debt issuing as part of a leverage buyout (LBO) What is an LBO? How to decide among these options? In this chapter we should talk about
More informationChapter Seven 9/25/2018. Chapter 6 The Risk Structure and Term Structure of Interest Rates. Bonds Are Risky!!!
Chapter Seven Chapter 6 The Risk Structure and Term Structure of Interest Rates Bonds Are Risky!!! Bonds are a promise to pay a certain amount in the future. How can that be risky? 1. Default risk - the
More informationFinancing decisions (2) Class 16 Financial Management,
Financing decisions (2) Class 16 Financial Management, 15.414 Today Capital structure M&M theorem Leverage, risk, and WACC Reading Brealey and Myers, Chapter 17 Key goal Financing decisions Ensure that
More informationOLD/PRACTICE Final Exam
OLD/PRACTICE Final Exam ADM 335 M&N Corporate Finance Professors: Kaouthar Lajili Devinder Ghandi Time: Three hours NAME: STUDENT NUMBER: SIGNATURE: GENERAL INSTRUCTIONS: Hand in everything at the end
More information15.414: COURSE REVIEW. Main Ideas of the Course. Approach: Discounted Cashflows (i.e. PV, NPV): CF 1 CF 2 P V = (1 + r 1 ) (1 + r 2 ) 2
15.414: COURSE REVIEW JIRO E. KONDO Valuation: Main Ideas of the Course. Approach: Discounted Cashflows (i.e. PV, NPV): and CF 1 CF 2 P V = + +... (1 + r 1 ) (1 + r 2 ) 2 CF 1 CF 2 NP V = CF 0 + + +...
More informationMGT201 Financial Management All Subjective and Objective Solved Midterm Papers for preparation of Midterm Exam2012 Question No: 1 ( Marks: 1 ) - Please choose one companies invest in projects with negative
More informationCorporate Finance. Dr Cesario MATEUS Session
Corporate Finance Dr Cesario MATEUS cesariomateus@gmail.com www.cesariomateus.com Session 3 20.02.2014 Selecting the Right Investment Projects Capital Budgeting Tools 2 The Capital Budgeting Process Generation
More informationCapital Structure. Outline
Capital Structure Moqi Groen-Xu Outline 1. Irrelevance theorems: Fisher separation theorem Modigliani-Miller 2. Textbook views of Financing Policy: Static Trade-off Theory Pecking Order Theory Market Timing
More information80 Solved MCQs of MGT201 Financial Management By
80 Solved MCQs of MGT201 Financial Management By http://vustudents.ning.com Question No: 1 ( Marks: 1 ) - Please choose one What is the long-run objective of financial management? Maximize earnings per
More informationCapital Structure. Katharina Lewellen Finance Theory II February 18 and 19, 2003
Capital Structure Katharina Lewellen Finance Theory II February 18 and 19, 2003 The Key Questions of Corporate Finance Valuation: How do we distinguish between good investment projects and bad ones? Financing:
More information3/15/2018 DUALITY AND GLOBALITY IN RISK MANAGEMENT STRATEGGY DUALITY
DUALITY AND GLOBALITY IN RISK MANAGEMENT STRATEGGY DUALITY The essence of duality is that in managing risks one can: Address the cause of the risk i.e. remove the risk Address the effect of the risk -
More informationDUALITY AND GLOBALITY IN RISK MANAGEMENT STRATEGGY
DUALITY AND GLOBALITY IN RISK MANAGEMENT STRATEGGY DUALITY The essence of duality is that in managing risks one can: Address the cause of the risk i.e. remove the risk Address the effect of the risk -
More informationCHAPTER 4 Bonds and Their Valuation Key features of bonds Bond valuation Measuring yield Assessing risk
4-1 CHAPTER 4 Bonds and Their Valuation Key features of bonds Bond valuation Measuring yield Assessing risk 4-2 Key Features of a Bond 1. Par value: Face amount; paid at maturity. Assume $1,000. 2. Coupon
More information*Efficient markets assumed
LECTURE 1 Introduction To Corporate Projects, Investments, and Major Theories Corporate Finance It is about how corporations make financial decisions. It is about money and markets, but also about people.
More informationChapters 10&11 - Debt Securities
Chapters 10&11 - Debt Securities Bond characteristics Interest rate risk Bond rating Bond pricing Term structure theories Bond price behavior to interest rate changes Duration and immunization Bond investment
More informationSolutions For the benchmark maturity sectors in the United States Treasury bill markets,
FIN 684 Professor Robert Hauswald Fixed-Income Analysis Kogod School of Business, AU Solutions 1 1. For the benchmark maturity sectors in the United States Treasury bill markets, Bloomberg reported the
More informationCHAPTER 14. Bond Characteristics. Bonds are debt. Issuers are borrowers and holders are creditors.
Bond Characteristics 14-2 CHAPTER 14 Bond Prices and Yields Bonds are debt. Issuers are borrowers and holders are creditors. The indenture is the contract between the issuer and the bondholder. The indenture
More informationOptimal Capital Structure
Capital Structure Optimal Capital Structure What is capital structure? How should a firm choose a debt-toequity ratio? The goal: Which is done by: Which is done by: Financial Leverage Scenario A B C Market
More informationBonds and Their Valuation
Chapter 7 Bonds and Their Valuation Key Features of Bonds Bond Valuation Measuring Yield Assessing Risk 7 1 What is a bond? A long term debt instrument in which a borrower agrees to make payments of principal
More informationFINANCE BASIC FOR MANAGERS SUMMER 2015 FINAL EXAM
Chapter 1 1. Which of the following statements concerning the cash flow production cycle is true? A. The profits reported in a given time period equal the cash flows generated. B. A company's operations
More informationMIDTERM EXAMINATION FALL
MIDTERM EXAMINATION FALL 2010 MGT411-Money & Banking By VIRTUALIANS.PK SOLVED MCQ s FILE:- Question # 1 Wider the range of outcome wider will be the. Risk Profit Probability Lose Question # 2 Prepared
More informationLecture 13: The Equity Premium
Lecture 13: The Equity Premium October 27, 2016 Prof. Wyatt Brooks Types of Assets This can take many possible forms: Stocks: buy a fraction of a corporation Bonds: lend cash for repayment in the future
More informationAll In One MGT201 Mid Term Papers More Than (10) BY
All In One MGT201 Mid Term Papers More Than (10) BY http://www.vustudents.net MIDTERM EXAMINATION MGT201- Financial Management (Session - 2) Question No: 1 ( Marks: 1 ) - Please choose one Why companies
More informationRisk -The most important concept of investment
Investment vs. Saving How is investing different from saving? Investing means putting money to work to earn a rate of, while saving means put the money in a home safe, or a safe deposit box. Investments
More informationBond Prices and Yields
Bond Characteristics 14-2 Bond Prices and Yields Bonds are debt. Issuers are borrowers and holders are creditors. The indenture is the contract between the issuer and the bondholder. The indenture gives
More informationChapter 14 The Cost of Capital
Topics Covered Chapter 14 The Cost of Capital Konan Chan Financial Management, Fall 2018 Cost of capital Weighted average cost of capital (WACC) Capital structure Required rates of return Divisional costs
More informationRecitation VI. Jiro E. Kondo
Recitation VI Jiro E. Kondo Summer 2003 Today s Recitation: Capital Structure. I. MM Thm: Capital Structure Irrelevance. II. Taxes and Other Deviations from MM. 1 I. MM Theorem. A company is considering
More informationPage 515 Summary and Conclusions
Page 515 Summary and Conclusions 1. We began our discussion of the capital structure decision by arguing that the particular capital structure that maximizes the value of the firm is also the one that
More informationWhat do Microsoft, Lexmark, and Ford have in common? In 2009, all three companies
CHAPTER 14 Capital Structure: Basic Concepts OPENING CASE What do Microsoft, Lexmark, and Ford have in common? In 2009, all three companies made announcements that would alter their balance sheets. Microsoft,
More informationCHAPTER 13 RISK, COST OF CAPITAL, AND CAPITAL BUDGETING
CHAPTER 13 RISK, COST OF CAPITAL, AND CAPITAL BUDGETING Answers to Concepts Review and Critical Thinking Questions 1. No. The cost of capital depends on the risk of the project, not the source of the money.
More informationMGT201 Financial Management Solved MCQs A Lot of Solved MCQS in on file
MGT201 Financial Management Solved MCQs A Lot of Solved MCQS in on file Which group of ratios measures a firm's ability to meet short-term obligations? Liquidity ratios Debt ratios Coverage ratios Profitability
More informationWeek 1 FINC $260,000 $106,680 $118,200 $89,400 $116,720. Capital Budgeting Analysis
Dr. Ahmed FINC 5880 Week 1 Name Capital Budgeting Analysis Facts: Calculations Cost $200,000 Shipping $10,000 Installation $30,000 Depreciable cost $24,000 Inventories will rise by $25,000 Payables will
More informationMGT201 Financial Management Solved MCQs
MGT201 Financial Management Solved MCQs Why companies invest in projects with negative NPV? Because there is hidden value in each project Because there may be chance of rapid growth Because they have invested
More informationPAPER No. 8: Financial Management MODULE No. 27: Capital Structure in practice
Subject Financial Management Paper No. and Title Module No. and Title Module Tag Paper No.8: Financial Management Module No. 27: Capital Structure in Practice COM_P8_M27 TABLE OF CONTENTS 1. Learning outcomes
More informationChapter 20: Financial Options
Chapter 20: Financial Options-1 Chapter 20: Financial Options I. Options Basics A. Understanding Option Contracts 1. Quick overview Option: an option gives the holder the right to buy or sell some asset
More informationAFM 371 Winter 2008 Chapter 16 - Capital Structure: Basic Concepts
AFM 371 Winter 2008 Chapter 16 - Capital Structure: Basic Concepts 1 / 24 Outline Background Capital Structure in Perfect Capital Markets Examples Leverage and Shareholder Returns Corporate Taxes 2 / 24
More informationCHAPTER 14. Bond Prices and Yields INVESTMENTS BODIE, KANE, MARCUS. Copyright 2011 by The McGraw-Hill Companies, Inc. All rights reserved.
CHAPTER 14 Bond Prices and Yields INVESTMENTS BODIE, KANE, MARCUS McGraw-Hill/Irwin Copyright 2011 by The McGraw-Hill Companies, Inc. All rights reserved. INVESTMENTS BODIE, KANE, MARCUS 14-2 Bond Characteristics
More informationUniversity of Waterloo Final Examination
University of Waterloo Final Examination Term: Fall 2008 Last Name First Name UW Student ID Number Course Abbreviation and Number AFM 372 Course Title Math Managerial Finance 2 Instructor Alan Huang Date
More informationJEM034 Corporate Finance Winter Semester 2017/2018
JEM034 Corporate Finance Winter Semester 2017/2018 Lecture #9 Olga Bychkova Topics Covered Today Does debt policy matter? (chapter 17 in BMA) How much should a corporation borrow? (chapter 18 in BMA) Debt
More informationChapter 5. Bonds, Bond Valuation, and Interest Rates
Chapter 5 Bonds, Bond Valuation, and Interest Rates 1 Chapter 5 applies Time Value of Money techniques to the valuation of bonds, defines some new terms, and discusses how interest rates are determined.
More informationDARTMOUTH COLLEGE, DEPARTMENT OF ECONOMICS ECONOMICS 21. Dartmouth College, Department of Economics: Economics 21, Summer 02. Topic 5: Information
Dartmouth College, Department of Economics: Economics 21, Summer 02 Topic 5: Information Economics 21, Summer 2002 Andreas Bentz Dartmouth College, Department of Economics: Economics 21, Summer 02 Introduction
More informationFINALTERM EXAMINATION Spring 2009 MGT201- Financial Management (Session - 3) Question No: 1 ( Marks: 1 ) - Please choose one Which of the following type of lease is a long-term lease that is not cancelable
More informationCapital Structure I. Corporate Finance and Incentives. Lars Jul Overby. Department of Economics University of Copenhagen.
Capital Structure I Corporate Finance and Incentives Lars Jul Overby Department of Economics University of Copenhagen December 2010 Lars Jul Overby (D of Economics - UoC) Capital Structure I 12/10 1 /
More informationFinance: Risk Management
Winter 2010/2011 Module III: Risk Management Motives steinorth@bwl.lmu.de Perfect financial markets Assumptions: no taxes no transaction costs no costs of writing and enforcing contracts no restrictions
More informationRisk and Return: From Securities to Portfolios
FIN 614 Risk and Return 2: Portfolios Professor Robert B.H. Hauswald Kogod School of Business, AU Risk and Return: From Securities to Portfolios From securities individual risk and return characteristics
More informationBOND NOTES BOND TERMS
BOND NOTES DEFINITION: A bond is a commitment by the issuer (the company that is borrowing the money) to pay a rate of interest for a pre-determined period of time. By selling bonds, the issuing company
More informationChapter 13. Risk, Cost of Capital, and Valuation 13-0
Chapter 13 Risk, Cost of Capital, and Valuation 13-0 Key Concepts and Skills Know how to determine a firm s cost of equity capital Understand the impact of beta in determining the firm s cost of equity
More informationFIN 684 Fixed-Income Analysis Corporate Debt Securities
FIN 684 Fixed-Income Analysis Corporate Debt Securities Professor Robert B.H. Hauswald Kogod School of Business, AU Corporate Debt Securities Financial obligations of a corporation that have priority over
More informationCHAPTER 11. Topics. Cash Flow Estimation and Risk Analysis. Estimating cash flows: Relevant cash flows Working capital treatment
CHAPTER 11 Cash Flow Estimation and Risk Analysis 1 Topics Estimating cash flows: Relevant cash flows Working capital treatment Risk analysis: Sensitivity analysis Scenario analysis Simulation analysis
More informationLeverage and Capital Structure The structure of a firm s sources of long-term financing
70391 - Finance Leverage and Capital Structure The structure of a firm s sources of long-term financing 70391 Finance Fall 2016 Tepper School of Business Carnegie Mellon University c 2016 Chris Telmer.
More informationTHE HONG KONG INSTITUTE OF CHARTERED SECRETARIES THE INSTITUTE OF CHARTERED SECRETARIES AND ADMINISTRATORS
THE HONG KONG INSTITUTE OF CHARTERED SECRETARIES THE INSTITUTE OF CHARTERED SECRETARIES AND ADMINISTRATORS International Qualifying Scheme Examination CORPORATE FINANCIAL MANAGEMENT PILOT PAPER Marking
More informationTaxes and Financing Decisions. Jonathan Lewellen & Katharina Lewellen
Taxes and Financing Decisions Jonathan Lewellen & Katharina Lewellen Overview Taxes and corporate decisions What are the tax effects of capital structure choices? How do taxes affect the cost of capital?
More informationIntroduction. Balance Sheet Model
Introduction (Text reference: Chapter 1) Topics Balance sheet model Interactions with financial markets Emphasis on cash flows Corporate securities as contingent claims orms of business organization Goals
More informationChapter 18 Interest rates / Transaction Costs Corporate Income Taxes (Cash Flow Effects) Example - Summary for Firm U Summary for Firm L
Chapter 18 In Chapter 17, we learned that with a certain set of (unrealistic) assumptions, a firm's value and investors' opportunities are determined by the asset side of the firm's balance sheet (i.e.,
More informationThe homework assignment reviews the major capital structure issues. The homework assures that you read the textbook chapter; it is not testing you.
Corporate Finance, Module 19: Adjusted Present Value Homework Assignment (The attached PDF file has better formatting.) Financial executives decide how to obtain the money needed to operate the firm:!
More informationWrap-Up of the Financing Module
Wrap-Up of the Financing Module The Big Picture: Part I - Financing A. Identifying Funding Needs Feb 6 Feb 11 Case: Wilson Lumber 1 Case: Wilson Lumber 2 B. Optimal Capital Structure: The Basics Feb 13
More informationA Random Walk Down Wall Street
FIN 614 Capital Market Efficiency Professor Robert B.H. Hauswald Kogod School of Business, AU A Random Walk Down Wall Street From theory of return behavior to its practice Capital market efficiency: the
More informationLeverage. Capital Budgeting and Corporate Objectives
Leverage Capital Budgeting and Corporate Objectives Professor Ron Kaniel Simon School of Business University of Rochester 1 Overview Capital Structure does not matter!» Modigliani & Miller propositions
More informationINTRODUCTION TO RISK AND RETURN IN CAPITAL BUDGETING Chapters 7-9
INTRODUCTION TO RISK AND RETURN IN CAPITAL BUDGETING Chapters 7-9 WE ALL KNOW: THE GREATER THE RISK THE GREATER THE REQUIRED (OR EXPECTED) RETURN... Expected Return Risk-free rate Risk... BUT HOW DO WE
More informationMGT411 Midterm Subjective Paper Solved BY SADIA ALI SADI (MBA) PLEASE PRAY FOR ME
Question No: 1(Marks: 3) Briefly discuss different types of investment grades of Long term ratings be PACRA. PACRA is the Pakistan Credit rating agency which rates different companies in Pakistan who offer
More informationM.V.S.R Engineering College. Department of Business Managment
M.V.S.R Engineering College Department of Business Managment CONCEPTS IN FINANCIAL MANAGEMENT 1. Finance. a.finance is a simple task of providing the necessary funds (money) required by the business of
More informationCHAPTER 11. Proposed Project Data. Topics. Cash Flow Estimation and Risk Analysis. Estimating cash flows:
CHAPTER 11 Cash Flow Estimation and Risk Analysis 1 Topics Estimating cash flows: Relevant cash flows Working capital treatment Inflation Risk Analysis: Sensitivity Analysis, Scenario Analysis, and Simulation
More informationMore Tutorial at Corporate Finance
[Type text] More Tutorial at Corporate Finance Question 1. Hardwood Factories, Inc. Hardwood Factories (HF) expects earnings this year of $6/share, and it plans to pay a $4 dividend to shareholders this
More informationChapter 12: Estimating the Cost of Capital
Chapter 12: Estimating the Cost of Capital -1 Chapter 12: Estimating the Cost of Capital Fundamental question: Where do we get the numbers to estimate the cost of capital? => How do we implement the CAPM
More informationCost of Capital (represents risk)
Cost of Capital (represents risk) Cost of Equity Capital - From the shareholders perspective, the expected return is the cost of equity capital E(R i ) is the return needed to make the investment = the
More information