Corporate Finance - Demo 2

Transcription

1 Copoate Finance - emo 2 Capital Stuctue and aluation Aalto Univesity School of Business Fall 2016

2 Review: Capital Stuctue ~ ebt Policy ~ Leveage ~ / Ratio 1. In theoy (pefect makets) : ebt policy doesn t matte! a) Pefect maket b) Modigliani Mille (MM) Popositions: No optimal / atio. MM I: Capital stuctue ielevance MM II: Leveage s impact on etuns c) aluation (when capital budgeting & financing decisions ae independent): The size of a pie is independent of how it is sliced. 2. In pactice (impefect makets): ebt policy does matte! a) Maket impefections: Inteest Tax Shields Financial istess Costs b) MM Opponents: Capital stuctue tade-off theoy (Optimal / atio) Pecking ode theoy (Optimal ode of financing choices) c) aluation (when capital budgeting & financing decisions inteact): Adjust the discount ate: WACC Adjust the base-case NP: AP Chaptes: 17, (18, 19) 2

3 Review: Capital Stuctue ~ ebt Policy ~ Leveage ~ / Ratio 1. In theoy (pefect maket assumptions) : ebt policy doesn t matte! a) Modigliani Mille (MM) Popositions: no optimal / atio! MM I: Capital stuctue ielevance (/ atio fim value, pice, A unaffected) All-quity Leveed, A_ afte A_ befoe, A _ afte A _ befoe, b A_ afte b A_ befoe A ROA xpected Opeating Income Maket alue Fim value is detemined by the LHS (assets), not RHS (debt and equity) MM II: Leveage s impact on etuns (/ atio b,, WACC A unaffected) WACC A + A + A + + bpotfolio b A b + b b b A + A ( - ) ( b b ) b) aluation (capital budgeting & financing decisions ae independent): The size of a pie is independent of how it is sliced. Chaptes: 17, (18, 19) 3

4 Review: Capital Stuctue ~ ebt Policy ~ Leveage ~ / Ratio 1. In theoy (pefect maket) : ebt policy doesn t matte! (No optimal / atio) 2. In pactice (impefect maket): ebt policy does matte! (Optimal / atio) Opeating income is also unaffected and maket value is flat as debt atio vaies. Chaptes: 17, (18, 19) 4

5 Review: Capital Stuctue ~ ebt Policy ~ Leveage ~ / Ratio 1. In theoy (pefect maket) : ebt policy doesn t matte! a) Pefect maket: b) Modigliani Mille (MM) Popositions: No optimal / atio. MM I: Capital stuctue ielevance MM II: Leveage s impact on etuns c) aluation (when capital budgeting & financing decisions ae independent): The size of a pie is independent of how it is sliced. 2. In pactice (impefect maket): ebt policy does matte! a) Maket impefections: Inteest Tax Shields Financial istess Costs b) MM Opponents: Capital stuctue tade-off theoy (Optimal / atio) Pecking ode theoy (Optimal ode of financing choices) c) aluation (when investment & financing decisions inteact): Adjust the discount ate (WACC) Adjust the base-case NP (AP) Chaptes: (17), 18, 19 5

6 Review: Capital Stuctue ~ ebt Policy ~ Leveage ~ / Ratio 2. In pactice (impefect maket): ebt policy does matte! a) Maket impefections: Taxes + P Tax _ Shield Copoate taxes: debt inteest is tax deductable P tax _ shield Tc (Assume Pemanent ebt) Pesonal taxes: Relative tax advantage of debt Financial istess bankuptcy cost (diect, indiect) P Financial _ istess _ Costs financial distess cost (vaying with assets) - Afte - tax WACC 1 1-Tp (1 -T )(1 -T ) conflicts of inteests of shaeholdes & debtholdes (game costs) p C ( -T ) c b) Financing choices - optimal / atio: Capital stuctue tade-off theoy: all- equity + PTax _ Shield - PFinancial _ istess _ Costs Pecking ode theoy: Intenal funds (einvested eanings) fi debt fi equity Chaptes: (17), 18, 19 6

7 Review: Capital Stuctue ~ ebt Policy ~ Leveage ~ / Ratio c) aluation (when capital budgeting & financing decisions inteact): i. When capital budgeting is independent of financing decisions: ii. Fou steps to evaluate a poject: Foecast futue afte-tax cash flows (assuming all-equity financing) Assess isk stimate oppotunity cost of capital Find NP using When capital budgeting & financing decisions inteact: Adjust the discount ate: Afte-tax WACC Assumptions (same business isk level, constant debt atio afte the estuctuing) Thee-step adjustment fo afte-tax WACC: alue businesses: P FCF 1 FCF WACC A ( MM _ wold ) fi new fi new WACC ( 1-Tc ) + FCFH WACC PH + 1+ WACC 2 H ( 1+ WACC) ( ) ( ) ( ) H Adjust the pesent value: AP AP (assumptions, value businesses, eg. Tade-off): AP NP base P - case + I i 1 Financing_ Side_ ffects 7

8 Review: Capital Stuctue ~ ebt Policy ~ Leveage ~ / Ratio 1. In theoy (pefect maket) : ebt policy doesn t matte! No optimal / atio 2. In pactice (impefect maket): ebt policy does matte! Optimal debt policy! Chaptes: (17), 18, 19 8

9 Poblem 1: Tue/False The objective to maximize the fim value is equivalent to the objective to minimize the cost of capital. Thus, manages should ty to lowe the cost of capital by boowing moe because the cost of debt is lowe than the cost of equity 9

10 Poblem 1: Tue/False The fim value maximization and the cost of capital minimization ae not always equivalent. It holds only if the opeating income is not affected by leveage change. Unde pefect maket conditions, fim cannot lowe the cost of capital by boowing moe because MM-II states that the equied ate of etun on equity inceases with an incease in popotion to debt so that the WACC does not change. 10

11 Poblem 2: Globocop Globocop is an all-equity financed fim and its stock has a beta of 1. The stock is piced to offe a 10% expected etun. The company decides to epuchase half of the common stock and substitute an equal value of debt. Assume that the debt yields a isk-fee etun of 5%. a) Calculate The beta of the debt. The beta of the common stock afte the efinancing. The beta of the company afte the efinancing. b) Calculate Investos equied etun on the common stock befoe efinancing. The equied etun on the common stock afte the efinancing. The equied etun on the debt. The equied etun on the company afte the efinancing. 11

12 Poblem 2: Globocop a) Calculate the Betas. The beta of the debt. ebt is isk-fee: b 0 (by definition) ( ) Using CAPM: + b - f f m f b 0 12

13 Poblem 2: Globocop a) Calculate the Betas. The beta of the common stock afte the efinancing. Weighted aveage: : ba _ 1 Afte: b A _ Afte b A _ b + b 1 0* + b _ 2 b _ Afte Afte 1 1 * 1 2 _ Afte 2 13

14 Poblem 2: Globocop a) Calculate the Betas. The beta of the company afte the efinancing. Risk of the assets is unaffected. Theefoe, beta of the company emains the same: ba _ Afte 1 14

15 Poblem 2: Globocop b) Calculate Investos equied etun on the common stock befoe efinancing. It is given: _ A _ 10% All equity financed befoe efinancing. 15

16 Poblem 2: Globocop b) Calculate The equied etun on the common stock afte the efinancing. Using WACC: ( - ) 10% + ( 10% - 5% ) 1 15% _ Afte A + A Altenatively, using CAPM: _ Afte _ Afte f + b _ Afte ( - ) 5% + 2 (10% - 5%) m f 15% (Why is m 10% hee?) 16

17 Poblem 2: Globocop b) Calculate The equied etun on the debt. Again, debt is isk-fee: f 5% The equied etun on the company afte the efinancing. Same as befoe: A _ Afte 10% 17

18 Poblem 3: Micotech Micotech opeates in the M&M wold without taxes. Its shaes have a beta of 1.7, the company s WACC is 11% and the expected etun on its bonds is 7% (debt is isky). The isk-fee ate of etun is 6.5%, and the maket potfolio has an expected etun of 11.5%. a) What is the company s / atio? b) Suppose Micotech issues debt to buy back half of its shaes. The beta of Micotech s stock inceases to 2.4 following the estuctuing, what is the new expected etun on the company s bonds? 18

19 Poblem 3: Micotech a) What is the company s / atio? In the WACC fomula, don t know / &! Use CAPM fo : Now, solve fo /: f + b m f 1 ( - ) 6.5% ( 11.5% - 6.5% ) 15% A 1 11% + Ł - ł A % 15% - - 7% 7%

20 Poblem 3: Micotech b) Suppose Micotech issues debt to buy back half of its shaes. If the beta of Micotech s stock inceases to 2.4 following the estuctuing, what is the new expected etun on the company s bonds? Afte efinancing: 1 4 ; 3 4 Find _Afte using CAPM: ( - ) 6.5% ( 11.5% - 6.5% ) 18.5% _ Afte f + b m f Now, using WACC: 1 A - _ Afte 11% % 11% 4 _ + A Afte 8.5%

21 Poblem 3: Micotech b) (Continued) Altenative solution: Find b A using CAPM, then fom weighted-aveage-of-betas fomula obtain b, finally using CAPM again find : CAPM: Weighted: CAPM: A b A + b b f f + b A ( - ) m + b 1 Ł - 11% ł - - ba % -6.5% % -6.5% ( - ) 6.5% (11.5% -6.5%) 8.5% m f f b b A A m f f b

22 Poblem 4: High nd Costume High nd Costume is all-equity financed and its stock has a pice to eanings atio of 15. The company is consideing a capital estuctuing by substituting a thid of the common stock with an equal value of debt. The debt is issued at a isk-fee etun of 6%. Assuming that the opeating pofit emains constant, calculate the following: a) The pecentage incease in eanings pe shae following the estuctuing b) The new P/ atio 22

23 Poblem 4: High nd Costume a) The pecentage incease in eanings pe shae? anings Afte anings Inteest payment Inteest payment ebt x Inteest ate (6%) ebt 1/3 of Fim alue (i.e., equity value befoe estuctuing) P N 15PS N 15 anings ( 15 anings) anings Inteest 5 anings 6% 30% anings 23

24 24 a) (Continued) 5% Afte PS PS PS PS PS PS Afte anings anings anings Inteest anings anings % 30% Afte Afte Afte PS N N PS N anings PS ) 3 1 (1 70% - Poblem 4: High nd Costume

25 Poblem 4: High nd Costume a) and Afte Compaison on a Table: Afte P/ 15 P 15*PS 15*PS P*N15*PS*N 15*PS*N 0 (1/3) 5*PS*N Inteest on 0 6%0.3*PS*N anings PS*N 0.7*PS*N PS PS (0.7*PS*N) / (1-1/3)N --> 1.05*PS! 25

26 Poblem 4: High nd Costume b) The new P/ atio? The shae pice afte the estuctuing stays the same. Ł P ł Afte P PS Afte Afte P PS Afte 15 PS 1.05 PS

27 Poblem 4: High nd Costume b) The new P/ atio on the table Afte P/ *PS /1.05*PS --> P 15*PS 15*PS P*N15*PS*N 15*PS*N 0 (1/3) 5*PS*N Inteest on 0 6%0.3*PS*N anings PS*N 0.7*PS*N PS PS (0.7*PS*N) / (1-1/3)N --> 1.05*PS! 27

28 Poblem 5: Financial distess costs Westside Hotel expects its BIT to be 12 million evey yea into pepetuity. It has 60 million of debt outstanding, with an expected ate of etun (and inteest ate) of 6%. Wee it all-equity financed, it would have a 10% cost of capital. The copoate tax ate is 25%. The following table shows an estimate of the pesent value of financial distess costs at specified levels of debt: ebt P(Costs of financial distess) 60 million 10 million 65 million 11 million 70 million 13 million 75 million 16 million 80 million 20 million 28

29 Poblem 5: Financial distess costs a) What is the value of Westside Hotels? What is its / atio? Based on the AP method: all-equity + P Tax _ Shield - P Financial _ istess _ Costs 12m( ) m - 10m 95m m 95m- 60m

30 Poblem 5: Financial distess costs b) What is the value of Westside Hotels at its optimal capital stuctue? At what / atio is this? Assume the company can aise debt only in potions of 5 million, and that it uses the money to buy back shaes. 65m / m- 65m

31 Poblem 6: Luxo s WACC Luxo Gold has 2.5 million shaes which ae cuently tading at 84 pe shae and have an expected etun of 16%. The company also has debt with a maket value of 135 million, and an expected etun of 9%. Assume a MM wold with a copoate tax ate of 20%. a) Calculate Luxo s afte-tax WACC. b) Suppose Luxo adopts a moe consevative debt policy. It educes its debt atio to 20% (/ 0.2), and as a esult expeiences a dop in the expected etun of its bonds to 8.6 %. Recalculate Luxo s WACC unde these new assumptions. 31

32 Poblem 6: Luxo s WACC a) Calculate Luxo s afte-tax WACC. WACC (1 - Tc ) + 2.5m m 210m + 135m 345m WACC 9% (1-20%) 12.56% 135m 345m + 16% 210m 345m 32

33 Poblem 6: Luxo s WACC b) Suppose Luxo adopts a moe consevative debt policy. It educes its debt atio to 20%, and as a esult, expeiences a dop in the expected etun of its bonds to 8.6%. Recalculate Luxo s afte-tax WACC unde these new assumptions. Thee-step WACC Adjustment: (1) Unleve WACC (which also equals with no debt); A + 135m 210m 9 % + 16% 13.26% 345m 345m (2) Calculate fo 20% debt using the coesponding ; A + 20% (1-20%) ( - ) 13.26% + (13.26% -8.6%) 14.43% A 33

34 Poblem 6: Luxo s WACC b) Thee-step WACC Adjustment (Continued): (3) Finally, ecalculate WACC with the new, and weights: WACC (1 -Tc ) + 8.6% (1-20%) 20% % (1-20%) 12.92% 34

35 Poblem 7: Plant xpansion A chemical company is evaluating a $6 million plant expansion, which it estimates will geneate $750,000 in afte-tax cash, yea in and yea out, pepetually. The cash flow is assumed to occu at the end of each yea. The etun obtained on investments of compaable isk is 13%. a)calculate the poject s NP, assuming no tax shields. b)calculate the poject s NP, assuming thee ae tax shields fom the issuance of debt. The debt is fixed in amounts equal to 40% of the poject s cost and expected to yield a 9% inteest ate. The company s maginal tax ate is 20%. c)what level of annual income must the company each so that it would invest in the plant expansion? d)etemine the minimum acceptable intenal ate of etun. 35

36 Poblem 7: Plant xpansion a) Calculate the poject s NP, assuming no tax shields. NP Base-Case 750,000-6,000, ,769 < 13% 0 36

37 Poblem 7: Plant xpansion b) Calculate the poject s NP, assuming thee ae tax shields fom the issuance of debt. The debt is fixed in amounts equal to 40% of the poject s cost and expected to yield a 9% inteest ate. The company s maginal tax ate is 20%. Fixed debt 40% x $6m $2.4m P Tax TC _ Shield TC 20% 2,400, ,000 AP NP Base -Case + PTax _ Shield -230, , ,231 > 0 37

38 Poblem 7: Plant xpansion c) What level of annual income must the company each so that it would invest in the plant expansion? Beak-even annual income must satisfy: AP NP Base -Case + PTax _ Shield 0 Annual _ Net _ Income - 6,000, , % Annual Annual Net _ Income (6,000, ,000) 13% Net _ Income 717,600 38

39 Poblem 7: Plant xpansion d) etemine the minimum acceptable intenal ate of etun. It is based on the minimum acceptable annual income: Annual _ Net _ Income Investment _ in _ xpansion 717,600 6,000, % 39