Download A Theory of the Firm's Cost of Capital: How Debt Affects the by Ramesh K. S. Rao PDF

By Ramesh K. S. Rao

The price of capital proposal has myriad functions in company decision-making. the traditional method for deriving price of capital estimates is predicated at the seminal Modigliani-Miller analyses. This publication generalizes this framework to incorporate non-debt tax shields (e.g., depreciation), interactions among the borrowing cost and tax shields, and default concerns. It develops a number of new effects and exhibits how larger expense of capital and marginal tax expense estimates may be generated. The book's unified rate of capital conception is mentioned with accomplished numerical examples and graphical illustrations. This e-book should be of curiosity to company managers, lecturers, funding bankers, governmental companies, and personal businesses that generate price of capital estimates for public intake.

Show description

Read Online or Download A Theory of the Firm's Cost of Capital: How Debt Affects the Firm's Risk, Value, Tax Rate, and The... PDF

Similar corporate finance books

Naked Finance: Business Finance Pure and Simple

Bare Finance: company Finance natural and straightforward is a pleasant, obtainable, jargon-free consultant that makes finance enjoyable and fascinating for usual humans-essential studying for all managers, not only the monetary ones! Stripping the topic all the way down to fundamentals, bare Finance offers a transparent view of the 3 key ability units precious for all managers: comprehend the place you are going, comprehend what is going on round you and take keep an eye on of the place you are going.

Inside Private Equity: The Professional Investor's Handbook

Inside of deepest fairness explores the complexities of this asset category and introduces new methodologies that attach funding returns with wealth production. through offering simple examples, it demystifies conventional measures just like the IRR and demanding situations some of the universal assumptions approximately this asset classification.

Survey Research in Corporate Finance: Bridging the Gap between Theory and Practice

Company finance is a multifaceted self-discipline during which every little thing works in conception yet now not inevitably in perform. To bridge this hole, intelligently designed and done surveys are crucial in empirically validating conceptual hypotheses and the relative usefulness of assorted theories. Survey examine in company Finance is a distinct precis of state of the art survey learn in finance.

Additional info for A Theory of the Firm's Cost of Capital: How Debt Affects the Firm's Risk, Value, Tax Rate, and The...

Sample text

Our interest in this research is not on these cases per se; they serve only to ensure that the resultant cost of capital theory is consistent in every one of these cases. It is useful to illustrate, with reference to a specific situation, how Table 3 is used in developing our cost of capital results. Consider, for example, the situation where A < D. Four cases are possible: 3rd Reading A < X ∗: Xp A A < Xp < X ∗ X ∗ Xp A + rD A + rD < Xp Xo 16: rD , NTS, DTS, NPV A− 17: rD , DTS, NPV A− 18: rz , DTS, NPV A− X∗ 9: 10: 11: 12: A + rD 13: rD , NTS, DTS, NPV A− 14: rz , NTS, DTS, N P VA− 15: rz , DTS, NPV A− A + rD < Xo 1: 2: 3: 4: rD , NTS, DTS, NPV A+/− rz , NTS, DTS, N P VA+/− rz , DTS, NPV A+/− rz , NPV A+/− A + rD < Xo 5: rD , NTS, DTS, NPV A+/− 6: rD , DTS, NPV A+/− 7: rz , DTS, NPV A+/− 8 : rz , NPV A+/− Xo rD , NTS, DTS, NPVA+ rD , DTS, NPVA+ r11 , NPVA+ rz , NPVA+ ch04 25 rz : Debt is riskless and par yield = rz ; rD : Debt is risky and par yield = rD ; r11 : Debt is risky and par yield = r11 ; NTS: Depreciation (non-debt) tax shield is risky; DTS: Debt tax shield is risky; DTSW: Debt tax shield is worthless; NPV A+ : NPV A is positive; NPV A− : NPV A is negative or zero; NPV A+/− : Sign of NPV A may be positive or negative.

In case 11, all tax shields are fully utilized and the firm pays taxes, but after-tax cash flow is insufficient to fully repay debt principal. In case 12, all tax shields are fully utilized, the firm pays taxes, and after-tax funds are sufficient to fully repay creditors. The debt is riskless in case 12, since creditors are fully paid in both states of nature. The debt is risky in cases 9–11, since state “p” entails partial default on interest or principal or on both. The depreciation tax shield is riskless in cases 10–12, since the cash flow from the depreciation deduction is a constant AT in ˜ NTS in Table 2).

Impact of an incremental debt dollar on levered firm risk and value. 3rd Reading December 12, 2006 11:15 spi-b456 A Theory of the Firm’s Cost of Capital 9in x 6in Discussion of Results ch05 3rd Reading 39 ~ Φ D+E ΦD+E, o ΦD+E, p Xp Xo A+rD A+r D ~ X Scenario 3. An incremental debt dollar produces no incremental tax shield. βD+E and VD+E are unaffected. This situation arises in cases 13–20: Xo A + rD. Figure 2. (Continued) incremental debt dollar generates tax shields in both the “o” and the “p” states, causing levered firm cash flows to increase by an equal amount.

Download PDF sample

Rated 4.11 of 5 – based on 6 votes