公司税和债务政策回顾

1Review•PreMid-Term--Debtvs.Equityoverview•LastLecture(Ch17)reintroducedthesetopics•Now-Wewillbegintoaddrealworldcomplexities.2TopicsCovered•DebtandValueinaTaxFreeEconomy•CorporateTaxesandDebtPolicy•CostofFinancialDistress•ExplainingFinancialChoices3M&M(DebtPolicyDoesn’tMatter)•Modigliani&Miller–Whentherearenotaxesandcapitalmarketsfunctionwell,itmakesnodifferencewhetherthefirmborrowsorindividualshareholdersborrow.Therefore,themarketvalueofacompanydoesnotdependonitscapitalstructure.4M&M(DebtPolicyDoesn’tMatter)Assumptions•Byissuing1securityratherthan2,companydiminishesinvestorchoice.Thisdoesnotreducevalueif:–Investorsdonotneedchoice,OR–Therearesufficientalternativesecurities•Capitalstructuredoesnotaffectcashflowse.g...–Notaxes–Nobankruptcycosts–Noeffectonmanagementincentives5Example-RiverCruises-AllEquityFinancedDataNumberofshares100,000Pricepershare$10MarketValueofShares$1millionOutcomeStateoftheEconomySlumpExpectedBoomOperatingIncome$75,000125,000175,000Earningspershare$.751.251.75Returnonshares(%)7.5%12.517.5M&M(DebtPolicyDoesn’tMatter)6Examplecont.50%debtDataNumberofshares50,000Pricepershare$10MarketValueofShares$500,000Marketvalueofdebt$500,000OutcomeStateoftheEconomySlumpExpectedBoomOperatingIncome$75,000125,000175,000Interest$50,00050,00050,000Equityearnings$25,00075,000125,000Earningspershare$.501.502.50Returnonshares(%)5%1525M&M(DebtPolicyDoesn’tMatter)7Example-RiverCruises-AllEquityFinanced-DebtreplicatedbyinvestorsOutcomeStateoftheEconomySlumpExpectedBoomEarningsontwoshares$1.502.503.50LESS:Interest@10%$1.001.001.00Netearningsoninvestment$.501.502.50Returnon$10investment(%)5%1525M&M(DebtPolicyDoesn’tMatter)8FinancialRisk-Risktoshareholdersresultingfromtheuseofdebt.FinancialLeverage-Increaseinthevariabilityofshareholderreturnsthatcomesfromtheuseofdebt.InterestTaxShield-Taxsavingsresultingfromdeductibilityofinterestpayments.C.S.&CorporateTaxes9Example-YouownalltheequityofSpaceBabiesDiaperCo..Thecompanyhasnodebt.Thecompany’sannualcashflowis$1,000,beforeinterestandtaxes.Thecorporatetaxrateis40%.Youhavetheoptiontoexchange1/2ofyourequitypositionfor10%bondswithafacevalueof$1,000.Shouldyoudothisandwhy?C.S.&CorporateTaxes10Example-YouownalltheequityofSpaceBabiesDiaperCo..Thecompanyhasnodebt.Thecompany’sannualcashflowis$1,000,beforeinterestandtaxes.Thecorporatetaxrateis40%.Youhavetheoptiontoexchange1/2ofyourequitypositionfor10%bondswithafacevalueof$1,000.Shouldyoudothisandwhy?AllEquity1/2DebtEBIT1,000InterestPmt0PretaxIncome1,000Taxes@40%400NetCashFlow$600C.S.&CorporateTaxes11AllEquity1/2DebtEBIT1,0001,000InterestPmt0100PretaxIncome1,000900Taxes@40%400360NetCashFlow$600$540Example-YouownalltheequityofSpaceBabiesDiaperCo..Thecompanyhasnodebt.Thecompany’sannualcashflowis$1,000,beforeinterestandtaxes.Thecorporatetaxrateis40%.Youhavetheoptiontoexchange1/2ofyourequitypositionfor10%bondswithafacevalueof$1,000.Shouldyoudothisandwhy?C.S.&CorporateTaxes12C.S.&CorporateTaxesAllEquity1/2DebtEBIT1,0001,000InterestPmt0100PretaxIncome1,000900Taxes@40%400360NetCashFlow$600$540TotalCashFlowAllEquity=600*1/2Debt=640(540+100)Example-YouownalltheequityofSpaceBabiesDiaperCo..Thecompanyhasnodebt.Thecompany’sannualcashflowis$1,000,beforeinterestandtaxes.Thecorporatetaxrateis40%.Youhavetheoptiontoexchange1/2ofyourequitypositionfor10%bondswithafacevalueof$1,000.Shouldyoudothisandwhy?13CapitalStructurePVofTaxShield=(assumeperpetuity)DxrDxTcrD=DxTc14CapitalStructurePVofTaxShield=(assumeperpetuity)DxrDxTcrD=DxTcExample:Taxbenefit=1000x(.10)x(.40)=$4015CapitalStructurePVofTaxShield=(assumeperpetuity)DxrDxTcrD=DxTcExample:Taxbenefit=1000x(.10)x(.40)=$40PVof40perpetuity=40/.10=$40016CapitalStructurePVofTaxShield=(assumeperpetuity)DxrDxTcrD=DxTcExample:Taxbenefit=1000x(.10)x(.40)=$40PVof40perpetuity=40/.10=$400PVTaxShield=DxTc=1000x.4=$40017CapitalStructureFirmValue=ValueofAllEquityFirm+PVTaxShield18CapitalStructureFirmValue=ValueofAllEquityFirm+PVTaxShieldExampleAllEquityValue=600/.10=6,00019CapitalStructureFirmValue=ValueofAllEquityFirm+PVTaxShieldExampleAllEquityValue=600/.10=6,000PVTaxShield=40020CapitalStructureFirmValue=ValueofAllEquityFirm+PVTaxShieldExampleAllEquityValue=600/.10=6,000PVTaxShield=400FirmValuewith1/2Debt=$6,40021C.S.&Taxes(Personal&Corp)RelativeAdvantageFormula(DebtvsEquity)1-TP(1-TPE)(1-TC)22C.S.&Taxes(Personal&Corp)RelativeAdvantageFormula(DebtvsEquity)1-TP(1-TPE)(1-TC)RAF1DebtRAF1EquityAdvantage23Example1AllDebtAllEquityIncomeBTCP1.00lessTC=.460.00IncomeBTP1.00TaxesTP=.5TPE=00.50AfterTaxIncome0.50C.S.&Taxes(Personal&Corp)24Example1AllDebtAllEquityIncomeBTCP1.001.00lessTC=.460.000.46IncomeBTP1.000.54TaxesTP=.5TPE=00.500.00AfterTaxIncome0.500.54C.S.&Taxes(Personal&Corp)25Example1AllDebtAllEquityIncomeBTCP1.001.00lessTC=.460.000.46IncomeBTP1.000.54TaxesTP=.5TPE=00.500.00AfterTaxIncome0.500.54RAF=.926AdvantageEquityC.S.&Taxes(Personal&Corp)26Example2AllDebtAllEquityIncomeBTCP1.00lessTC=.340.00IncomeBTP1.00TaxesTP=.28TPE=.210.28AfterTaxIncome0.72C.S.&Taxes(Personal&Corp)27Example2AllDebtAllEquityIncomeBTCP1.001.00