Corporate finance principles of principles of coporate finance brealey myers 12th edition 12 edition twelfth edition twelve economics corporate finance solution manual solution manual answers impacts minicase mini case Study guides, Class notes & Summaries
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Table of Contents
Chapter 16- Corporate Claims ................................................................................................ 3
The basic building blocks ................................................................................................................3
Liabilities .......................................................................................................................................5
Financial claims (debt) .......................................................................................................................................... 5
Non-financial liabilities ......................................................................................................................................... 9
Equity (stocks) ............................................................................................................................. 10
Preferred equity ................................................................................................................................................. 10
Observations on the evolution of Intel’s Capital Structure ................................................................................ 11
Chapter 17- Capital Structure in a perfect market ................................................................. 11
Maximization of equity or firm value ............................................................................................ 11
Modigliani-Miller ......................................................................................................................... 13
Reflecting on arbitrage argument ...................................................................................................................... 14
Perceived vs. real value ...................................................................................................................................... 14
Weighted Average Cost of Capital (WACC) .................................................................................... 15
Risk aversion and higher equity cost of capital .................................................................................................. 15
In terms of Capital structure WACC ................................................................................................................... 17
WACC formula without taxes ............................................................................................................................. 17
Leverage, Cost of capital, and quoted interest rates ......................................................................................... 17
Graphing finance schemes against leverage ratios ............................................................................................ 18
If all securities are riskier, is the firm also riskier? ............................................................................................. 18
Leverage, earnings per share, and price/ earnings ratio.................................................................................... 19
Cost of capital nuances and non-financial liabilities....................................................................... 19
Value irrelevance with nonfinancial liabilities? .................................................................................................. 19
Marginal vs. average cost of capital ................................................................................................................... 20
Chapter 18- Taxes and Capital Structure ............................................................................... 21
Relative Taxation of debt and equity ............................................................................................ 21
Hypothetical equal taxation and capital budgeting ........................................................................................... 21
Realistic differential taxation of debt and equity ............................................................................................... 21
Firm value under different capital structures ................................................................................ 21
Formulaic valuation methods: APV and WACC .............................................................................. 22
Adjusted Present Value (APV): Theory ............................................................................................................... 22
Tax-adjusted weighted average cost of capital (WACC) valuation: Theory ....................................................... 23
Comparing flow-to-equity, APV, WACC, and avoiding bad ideas....................................................................... 25
Sample applications of tax-adjusted valuation .............................................................................. 25
Flow-to-equity direct valuation from the pro forma financials ......................................................................... 25
The APV Valuation .............................................................................................................................................. 26
, The WACC Valuation........................................................................................................................................... 27
Contemplating corporate taxes and leverage ................................................................................ 27
Which tax-adjusted valuation method is best? .................................................................................................. 27
A quick-and-dirty heuristic tax-savings rule ....................................................................................................... 28
Are investment and finance decisions separate now?....................................................................................... 28
The average and marginal cost of capital........................................................................................................... 29
Combining tax adjusted WACC and CAPM ......................................................................................................... 29
Personal income taxes and clientele effects .................................................................................. 29
The tax code for securities owners ............................................................................................... 29
Principle should be “Joint tax avoidance” .......................................................................................................... 30
Tax clienteles ...................................................................................................................................................... 30
Arrange clienteles .............................................................................................................................................. 31
Chapter 19- More imperfect-market capital structure ........................................................... 31
What really matters? ................................................................................................................... 31
Operating policy in bad times (distress) ........................................................................................ 32
The trade off in the presence of financial distress costs .................................................................................... 32
Direct losses of firm value .................................................................................................................................. 32
Operational distortions of incentives ................................................................................................................. 34
Strategic considerations ..................................................................................................................................... 35
Operating policy in good times (agency) ....................................................................................... 35
Bondholder expropriation ............................................................................................................ 36
Project risk changes ............................................................................................................................................ 36
Issuance of bonds of similar priority .................................................................................................................. 37
Counteracting forces against expropriation ....................................................................................................... 37
Private information and adverse selection .................................................................................... 38
Other important concerns ............................................................................................................ 39
Liquidity .............................................................................................................................................................. 39
Transaction costs ................................................................................................................................................ 39
Behavioral issues ................................................................................................................................................ 40
Static capital structure summary .................................................................................................. 40
The effect of leverage on the cost of capital and value .................................................................. 41
Valuing formulas with many market imperfections ....................................................................... 42
Do we need other valuation (WACC and APV) formulas? .................................................................................. 43
Capital structure dynamics ........................................................................................................... 44
Chapter 27- Options and Risk Management ......................................................................... 44
Options........................................................................................................................................ 44
Call options ......................................................................................................................................................... 45
Put options ......................................................................................................................................................... 46
More institutional stock option arrangements .................................................................................................. 46
Option payoffs at expiration .............................................................................................................................. 47
Static No-arbitrage relationships .................................................................................................. 49
Simple no-arbitrage requirements ..................................................................................................................... 49
, Put-call parity...................................................................................................................................................... 50
American early exercise feature ......................................................................................................................... 50
Valuing options from underlying stock prices ................................................................................ 51
The Black-Scholes inputs .............................................................................................................. 54
Obtaining Black-Scholes formula inputs............................................................................................................. 54
Comparative statics for the Black-Scholes formula............................................................................................ 55
Value prior to expiration .................................................................................................................................... 56
Option riskiness .................................................................................................................................................. 57
Corporate applications ................................................................................................................. 57
Securities as financial options ............................................................................................................................ 57
Real projects as options...................................................................................................................................... 58
Risk management ............................................................................................................................................... 58
Employee stock options...................................................................................................................................... 59
Chapter 20- Equity payouts: Dividends and Share Repurchases ............................................. 60
Background .................................................................................................................................60
Dividend mechanics ............................................................................................................................................ 61
Share repurchase mechanics .............................................................................................................................. 62
Perfect-market irrelevance ........................................................................................................... 63
Dividends and share repurchase ................................................................................................... 64
Personal Income Tax Differences and Investor Clienteles ................................................................................. 65
Non-tax related differences................................................................................................................................ 66
Empirical evidence .............................................................................................................................................. 67
Market reactions ................................................................................................................................................ 69
Survey Evidence ........................................................................................................................... 72
Chapter 16- Corporate Claims
The basic building blocks
• Corporate charter lays down the basics of a firm
o Specifies who holds decision power, how the firm can engage in further
contracts, and how the charter can be amended
o Also addresses how the firm may be governed in the future
o The charter facilitates the creation of financial and nonfinancial claims, each with
its own cash flow rights and control rights
o Can indicate how the capital structure of a firm is established
• Firms assets are owned by multiple claimants
o Liabilities (leverage) and equity (stocks)
• Shareholders are in charge but there are clear limits as to what they can do
o Such limitations are imposed by covenants that are accepted by the
shareholders
o Covenants are what is accepted when a firm borrows money
, o Example, most covenants on bonds prevents the firm from destroying or not
maintaining their assets, or selling the selling and paying out cash to
shareholders
• The set of all claims of the firm’s future payoffs is known as its capital structure
• Claims often classified as financial or nonfinancial
o Financial claims
▪ Debt and equity
▪ Loosely called securities as they are registered with the SEC
o Nonfinancial claims
▪ Are obligations such as corporate income taxes due, pension obligations
and accounts payable
• In order to fully own the firm and do whatever you want you must own all the claims
that the firm has issued
o It is not enough to own all the stock or just all the financial claims
o Can never really own all the claims as the government is entitled to some future
cash flows through taxes
• Every claim has two important aspects
o Cash flow rights
▪ How cash generated by the firm will be allocated
o Control rights
▪ Allow the claim owners to enforce their cash flow rights
▪ Example, creditors can force firm into bankruptcy if it doesn’t pay its
obligations
• Main tool for analysis of cash flow rights is a payoff diagram
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