CF2-Ch-14-Capital-Structure-Decisions-公司财务与金融-课件

Chapter16CapitalStructureDecisions1Chapter16CapitalStructureDeTopicsinChapterOverviewandpreviewofcapitalstructureeffectsBusinessversusfinancialriskTheimpactofdebtonreturnsCapitalstructuretheory,evidence,andimplicationsformanagersExample:Choosingtheoptimalstructure2TopicsinChapterOverviewandBasicDefinitionsV=valueoffirmFCF=freecashflowWACC=weightedaveragecostofcapitalrsandrdarecostsofstockanddebtreandwdarepercentagesofthefirmthatarefinancedwithstockanddebt.3BasicDefinitionsV=valueofHowcancapitalstructureaffectvalue?V=∑∞t=1FCFt(1+WACC)tWACC=wd(1-T)rd+wers4HowcancapitalstructureaffeAPreviewofCapitalStructureEffectsTheimpactofcapitalstructureonvaluedependsupontheeffectofdebton:WACCFCF(Continued…)5APreviewofCapitalStructureTheEffectofAdditional

DebtonWACCDebtholdershaveapriorclaimoncashflowsrelativetostockholders.Debtholders’“fixed”claimincreasesriskofstockholders’“residual”claim.Costofstock,rs,goesup.Firm’scandeductinterestexpenses.ReducesthetaxespaidFreesupmorecashforpaymentstoinvestorsReducesafter-taxcostofdebt(Continued…)6TheEffectofAdditional

DebtTheEffectonWACC(Continued)DebtincreasesriskofbankruptcyCausespre-taxcostofdebt,rd,toincreaseAddingdebtincreasepercentoffirmfinancedwithlow-costdebt(wd)anddecreasespercentfinancedwithhigh-costequity(we)NeteffectonWACC=uncertain.(Continued…)7TheEffectonWACC(Continued)TheEffectofAdditionalDebtonFCFAdditionaldebtincreasestheprobabilityofbankruptcy.Directcosts:Legalfees,“fire”sales,etc.Indirectcosts:Lostcustomers,reductioninproductivityofmanagersandlineworkers,reductionincredit(i.e.,accountspayable)offeredbysuppliers(Continued…)8TheEffectofAdditionalDebtImpactofindirectcostsNOPATgoesdownduetolostcustomersanddropinproductivityInvestmentincapitalgoesupduetoincreaseinnetoperatingworkingcapital(accountspayablegoesupassupplierstightencredit).(Continued…)9Impactofindirectcosts(ContiAdditionaldebtcanaffectthebehaviorofmanagers.Reductionsinagencycosts:debt“pre-commits,”or“bonds,”freecashflowforuseinmakinginterestpayments.Thus,managersarelesslikelytowasteFCFonperquisitesornon-valueaddingacquisitions.Increasesinagencycosts:debtcanmakemanagerstoorisk-averse,causing“underinvestment”inriskybutpositiveNPVprojects.(Continued…)10AdditionaldebtcanaffecttheAsymmetricInformation

andSignalingManagersknowthefirm’sfutureprospectsbetterthaninvestors.Managerswouldnotissueadditionalequityiftheythoughtthecurrentstockpricewaslessthanthetruevalueofthestock(giventheirinsideinformation).Hence,investorsoftenperceiveanadditionalissuanceofstockasanegativesignal,andthestockpricefalls.11AsymmetricInformation

andSiBusinessrisk:Uncertaintyaboutfuturepre-taxoperatingincome(EBIT).ProbabilityEBITE(EBIT)0LowriskHighriskNotethatbusinessriskfocusesonoperatingincome,soitignoresfinancingeffects.12Businessrisk:UncertaintyaboFactorsThatInfluenceBusinessRiskUncertaintyaboutdemand(unitsales).Uncertaintyaboutoutputprices.Uncertaintyaboutinputcosts.Productandothertypesofliability.Degreeofoperatingleverage(DOL).13FactorsThatInfluenceBusinesWhatisoperatingleverage,andhowdoesitaffectafirm’sbusinessrisk?OperatingleverageisthechangeinEBITcausedbyachangeinquantitysold.Thehighertheproportionoffixedcostswithinafirm’soverallcoststructure,thegreatertheoperatingleverage.(More...)14Whatisoperatingleverage,anHigheroperatingleverageleadstomorebusinessrisk:smallsalesdeclinecausesalargerEBITdecline.(More...)Sales$Rev.TCFQBEEBIT}$Rev.TCFQBESales15HigheroperatingleverageleadOperatingBreakevenQisquantitysold,Fisfixedcost,Visvariablecost,TCistotalcost,andPispriceperunit.Operatingbreakeven=QBEQBE=F/(P–V)Example:F=$200,P=$15,andV=$10:QBE=$200/($15–$10)=40.(More...)16OperatingBreakevenQisquantiProbabilityEBITLLowoperatingleverageHighoperatingleverageEBITHHigheroperatingleverageleadstohigherexpectedEBITandhigherrisk.17ProbabilityEBITLLowoperatingBusinessRiskversusFinancialRiskBusinessrisk:UncertaintyinfutureEBIT.Dependsonbusinessfactorssuchascompetition,operatingleverage,etc.Financialrisk:Additionalbusinessriskconcentratedoncommonstockholderswhenfinancialleverageisused.Dependsontheamountofdebtandpreferredstockfinancing.18BusinessRiskversusFinancialConsiderTwoHypotheticalFirmsFirmUFirmLNodebt $10,000of12%debt$20,000inassets$20,000inassets40%taxrate 40%taxrateBothfirmshavesameoperatingleverage,businessrisk,andEBITof$3,000.Theydifferonlywithrespecttouseofdebt.19ConsiderTwoHypotheticalFirmImpactofLeverageonReturnsFirmUFirmLEBIT $3,000$3,000Interest

01,200EBT $3,000$1,800Taxes(40%)1,200720NI $1,800$1,080ROE9.0%10.8%20ImpactofLeverageonReturnsFWhydoesleveragingincreasereturn?MoreEBITgoestoinvestorsinFirmL.Totaldollarspaidtoinvestors:U:NI=$1,800.L:NI+Int=$1,080+$1,200=$2,280.Taxespaid:U:$1,200;L:$720.Equity$proportionallylowerthanNI.21WhydoesleveragingincreaserContinued…NowconsiderthefactthatEBITisnotknownwithcertainty.WhatistheimpactofuncertaintyonstockholderprofitabilityandriskforFirmUandFirmL?22Continued…NowconsiderthefacFirmU:UnleveragedEconomyBadAvg.GoodProb.0.250.500.25EBIT$2,000$3,000$4,000Interest000EBT$2,000$3,000$4,000Taxes(40%)8001,2001,600NI$1,200$1,800$2,40023FirmU:UnleveragedEconomyBadAFirmL:LeveragedEconomyBadAvg.GoodProb.*0.250.500.25EBIT$2,000$3,000$4,000Interest1,2001,2001,200EBT$800$1,800$2,800Taxes(40%)3207201,120NI$480$1,080$1,680*sameasforFirmU24FirmL:LeveragedEconomyBadAvgFirmUBadAvg.GoodBEP10.0%15.0%20.0%ROIC6.0%9.0%12.0%ROE6.0%9.0%12.0%TIEn.a.n.a.n.a.FirmLBadAvg.GoodBEP10.0%15.0%20.0%ROIC6.0%9.0%12.0$ROE4.8%10.8%16.8%TIE1.7x2.5x3.3x25FirmUBadAvg.GoodBEP10.0%15.0ProfitabilityMeasures:ULE(BEP)15.0%15.0%E(ROIC)9.0%9.0%E(ROE)9.0%10.8%RiskMeasures:σROIC2.12%2.12%σROE2.12%4.24%26ProfitabilityMeasures:ULE(BEPConclusionsBasicearningpower(EBIT/TA)andROIC(NOPAT/Capital=EBIT(1-T)/TA)areunaffectedbyfinancialleverage.LhashigherexpectedROE:taxsavingsandsmallerequitybase.LhasmuchwiderROEswingsbecauseoffixedinterestcharges.Higherexpectedreturnisaccompaniedbyhigherrisk.(More...)27ConclusionsBasicearningpowerInastand-alonerisksense,FirmL’sstockholdersseemuchmoreriskthanFirmU’s.UandL:σROIC=2.12%.U:σROE=2.12%.L:σROE=4.24%.L’sfinancialriskisσROE-σROIC=4.24%-2.12%=2.12%.(U’siszero.)(More...)28Inastand-alonerisksense,FForleveragetobepositive(increaseexpectedROE),BEPmustbe>rd.Ifrd>BEP,thecostofleveragingwillbehigherthantheinherentprofitabilityoftheassets,sotheuseoffinancialleveragewilldepressnetincomeandROE.Intheexample,E(BEP)=15%whileinterestrate=12%,soleveraging“works.”29Forleveragetobepositive(iCapitalStructureTheoryMMtheoryZerotaxesCorporatetaxesCorporateandpersonaltaxesTrade-offtheorySignalingtheoryPeckingorderDebtfinancingasamanagerialconstraintWindowsofopportunity30CapitalStructureTheoryMMtheMMTheory:ZeroTaxesMMprove,underaveryrestrictivesetofassumptions,thatafirm’svalueisunaffectedbyitsfinancingmix:VL=VU.Therefore,capitalstructureisirrelevant.AnyincreaseinROEresultingfromfinancialleverageisexactlyoffsetbytheincreaseinrisk(i.e.,rs),soWACCisconstant.31MMTheory:ZeroTaxesMMproveMMTheory:CorporateTaxesCorporatetaxlawsfavordebtfinancingoverequityfinancing.Withcorporatetaxes,thebenefitsoffinancialleverageexceedtherisks:MoreEBITgoestoinvestorsandlesstotaxeswhenleverageisused.MMshowthat:VL=VU+TD.IfT=40%,theneverydollarofdebtadds40centsofextravaluetofirm.32MMTheory:CorporateTaxesCorValueofFirm,V0 DebtVLVUUnderMMwithcorporatetaxes,thefirm’svalueincreasescontinuouslyasmoreandmoredebtisused.TDMMrelationshipbetweenvalueanddebtwhencorporatetaxesareconsidered.33ValueofFirm,V0 DebtVLVUUndeCostofCapital(%)0 20 40 60 80 100Debt/ValueRatio(%)rsWACCrd(1-T)MMrelationshipbetweencapitalcostsandleveragewhencorporatetaxesareconsidered.34CostofCapital(%)0 20 40 60 Miller’sTheory:CorporateandPersonalTaxesPersonaltaxeslessentheadvantageofcorporatedebt:Corporatetaxesfavordebtfinancingsincecorporationscandeductinterestexpenses.Personaltaxesfavorequityfinancing,sincenogainisreporteduntilstockissold,andlong-termgainsaretaxedatalowerrate.35Miller’sTheory:CorporateandVL=VU+[1-]D.Tc=corporatetaxrate.Td=personaltaxrateondebtincome.Ts=personaltaxrateonstockincome.(1-Tc)(1-Ts)(1-Td)Miller’sModelwithCorporateandPersonalTaxes36(1-Tc)(1-Ts)Miller’sModel

VL =VU+[1-]D =VU+(1-0.75)D =VU+0.25D.Valueriseswithdebt;each$1increaseindebtraisesL’svalueby$0.25.(1-0.40)(1-0.12)(1-0.30)Tc=40%,Td=30%,

andTs=12%.37(1-0.40)(1-0.12)Tc=ConclusionswithPersonalTaxesUseofdebtfinancingremainsadvantageous,butbenefitsarelessthanunderonlycorporatetaxes.Firmsshouldstilluse100%debt.Note:However,Millerarguedthatinequilibrium,thetaxratesofmarginalinvestorswouldadjustuntiltherewasnoadvantagetodebt.38ConclusionswithPersonalTaxeTrade-offTheoryMMtheoryignoresbankruptcy(financialdistress)costs,whichincreaseasmoreleverageisused.Atlowleveragelevels,taxbenefitsoutweighbankruptcycosts.Athighlevels,bankruptcycostsoutweightaxbenefits.Anoptimalcapitalstructureexiststhatbalancesthesecostsandbenefits.39Trade-offTheoryMMtheoryignoSignalingTheoryMMassumedthatinvestorsandmanagershavethesameinformation.But,managersoftenhavebetterinformation.Thus,theywould:Sellstockifstockisovervalued.Sellbondsifstockisundervalued.Investorsunderstandthis,soviewnewstocksalesasanegativesignal.Implicationsformanagers?40SignalingTheoryMMassumedthaPeckingOrderTheoryFirmsuseinternallygeneratedfundsfirst,becausetherearenoflotationcostsornegativesignals.Ifmorefundsareneeded,firmsthenissuedebtbecauseithaslowerflotationcoststhanequityandnotnegativesignals.Ifmorefundsareneeded,firmsthenissueequity.41PeckingOrderTheoryFirmsuseDebtFinancingandAgencyCostsOneagencyproblemisthatmanagerscanusecorporatefundsfornon-valuemaximizingpurposes.Theuseoffinancialleverage:Bonds“freecashflow.”Forcesdisciplineonmanagerstoavoidperksandnon-valueaddingacquisitions.(More...)42DebtFinancingandAgencyCostAsecondagencyproblemisthepotentialfor“underinvestment”.Debtincreasesriskoffinancialdistress.Therefore,managersmayavoidriskyprojectseveniftheyhavepositiveNPVs.43AsecondagencyproblemistheInvestmentOpportunitySetandReserveBorrowingCapacityFirmswithmanyinvestmentopportunitiesshouldmaintainreserveborrowingcapacity,especiallyiftheyhaveproblemswithasymmetricinformation(whichwouldcauseequityissuestobecostly).44InvestmentOpportunitySetandWindowsofOpportunityManagerstryto“timethemarket”whenissuingsecurities.Theyissueequitywhenthemarketis“high”andafterbigstockpricerunups.Theyissuedebtwhenthestockmarketis“low”andwheninterestratesare“low.”Theissueshort-termdebtwhenthetermstructureisupwardslopingandlong-termdebtwhenitisrelativelyflat.45WindowsofOpportunityManagersEmpiricalEvidenceTaxbenefitsareimportant–$1debtaddsabout$0.10tovalue.SupportsMillermodelwithpersonaltaxes.Bankruptciesarecostly–costscanbeupto10%to20%offirmvalue.Firmsdon’tmakequickcorrectionswhenstockpricechangescausetheirdebtratiostochange–doesn’tsupporttrade-offmodel.46EmpiricalEvidenceTaxbenefitsEmpiricalEvidence(Continued)Afterbigstockpricerunups,debtratiofalls,butfirmstendtoissueequityinsteadofdebt.Inconsistentwithtrade-offmodel.Inconsistentwithpeckingorder.Consistentwithwindowsofopportunity.Manyfirms,especiallythosewithgrowthoptionsandasymmetricinformationproblems,tendtomaintainexcessborrowingcapacity.47EmpiricalEvidence(Continued)ImplicationsforManagersTakeadvantageoftaxbenefitsbyissuingdebt,especiallyifthefirmhas:HightaxrateStablesalesLessoperatingleverage48ImplicationsforManagersTakeImplicationsforManagers(Continued)Avoidfinancialdistresscostsbymaintainingexcessborrowingcapacity,especiallyifthefirmhas:VolatilesalesHighoperatingleverageManypotentialinvestmentopportunitiesSpecialpurposeassets(insteadofgeneralpurposeassetsthatmakegoodcollateral)49ImplicationsforManagers(ConImplicationsforManagers(Continued)Ifmanagerhasasymmetricinformationregardingfirm’sfutureprospects,thenavoidissuingequityifactualprospectsarebetterthanthemarketperceives.Alwaysconsidertheimpactofcapitalstructurechoicesonlenders’andratingagencies’attitudes50ImplicationsforManagers(ConChoosingtheOptimalCapitalStructure:ExampleCurrentlyisall-equityfinanced.ExpectedEBIT=$500,000.Firmexpectszerogrowth.100,000sharesoutstanding;rs=12%;P0=$25;T=40%;b=1.0;rRF=6%;RPM=6%.51ChoosingtheOptimalCapitalSEstimatesofCostofDebt%financedwithdebt,wdrd0%-20%8.0%30%8.5%40%10.0%50%12.0%Ifcompanyrecapitalizes,debtwouldbeissuedtorepurchasestock.52EstimatesofCostofDebt%finTheCostofEquityatDifferentLevelsofDebt:Hamada’sEquation

MMtheoryimpliesthatbetachangeswithleverage.bUisthebetaofafirmwhenithasnodebt(theunleveredbeta)bL=bU[1+(1-T)(D/S)]53TheCostofEquityatDifferenTheCostofEquityforwd=20%UseHamada’sequationtofindbeta:bL=bU[1+(1-T)(D/S)] =1.0[1+(1-0.4)(20%/80%)] =1.15UseCAPMtofindthecostofequity: rs=rRF+bL(RPM) =6%+1.15(6%)=12.9%54TheCostofEquityforwd=20CostofEquityvs.Leveragewd D/SbL

rs0% 0.001.00012.00%20% 0.251.15012.90%30% 0.431.25713.54%40% 0.671.40014.40%50% 1.001.60015.60%55CostofEquityvs.LeveragewdTheWACCforwd=20%WACC=wd(1-T)rd+wersWACC=0.2(1–0.4)(8%)+0.8(12.9%)WACC=11.28%Repeatthisforallcapitalstructuresunderconsideration.56TheWACCforwd=20%WACC=wdWACCvs.LeveragewdrdrsWACC0%0.0%12.00%12.00%20%8.0%12.90%11.28%30%8.5%13.54%11.01%40%10.0%14.40%11.04%50%12.0%15.60%11.40%57WACCvs.LeveragewdrdrsWACC0%0CorporateValueforwd=20%V=FCF/(WACC-g)g=0,soinvestmentincapitaliszero;soFCF=NOPAT=EBIT(1-T).NOPAT=($500,000)(1-0.40)=$300,000.V=$300,000/0.1128=$2,659,574.58CorporateValueforwd=20%VCorporateValuevs.LeveragewdWACCCorp.Value0%12.00%$2,500,00020%11.28%$2,659,57430%11.01%$2,724,79640%11.04%$2,717,39150%11.40%$2,631,57959CorporateValuevs.LeveragewdDebtandEquityforwd=20%Thedollarvalueofdebtis: D =wd V =0.2($2,659,574)=$531,915. S =V–D S =$2,659,574-$531,915 =$2,127,659.60DebtandEquityforwd=20%ThDebtandStockValuevs.LeveragewdDebt,DStockValue,S0%$0$2,500,00020%$531,915$2,127,66030%$817,439$1,907,35740%$1,086,957$1,630,43550%$1,315,789$1,315,789Note:thesearerounded;seeCh16MiniCase.xlsforfullcalculations.61DebtandStockValuevs.LeverWealthofShareholders Valueoftheequitydeclinesasmoredebtisissued,becausedebtisusedtorepurchasestock.Buttotalwealthofshareholdersisvalueofstockaftertherecapplusthecashreceivedinrepurchase,andthistotalgoesup(ItisequaltoCorporateValueonearlierslide).62WealthofShareholders ValueoStockPriceforwd=20%Thefirmissuesdebt,whichchangesitsWACC,whichchangesvalue.Thefirmthenusesdebtproceedstorepurchasestock.Stockpricechangesafterdebtisissued,butdoesnotchangeduringactualrepurchase(orarbitrageispossible).(More…)63StockPriceforwd=20%ThefiStockPriceforwd=20%(Continued)Thestockpriceafterdebtisissuedbutbeforestockisrepurchasedreflectsshareholderwealth:S,valueofstockCashpaidinrepurchase.(More…)64StockPriceforwd=20%(ContStockPriceforwd=20%(Continued)D0andn0aredebtandoutstandingsharesbeforerecap.D-D0isequaltocashthatwillbeusedtorepurchasestock.S+(D-D0)iswealthofshareholders’afterthedebtisissuedbutimmediatelybeforetherepurchase.(More…)65StockPriceforwd=20%(ContStockPriceforwd=20%(Continued)P=S+(D–D0)

n0 P=$2,127,660+($531,915–0)

100,000 P=$26.596pershare.66StockPriceforwd=20%(ContNumberofSharesRepurchased#Repurchased=(D-D0)/P #Rep. =($531,915–0)/$26.596 =20,000.#Remaining=n=S/P n =$2,127,660/$26.596 =80,000.67NumberofSharesRepurchased#PriceperSharevs.Leverage#shares#shareswdPRepurch.Remaining0%$25.000100,00020%$26.6020,00080,00030%$27.2530,00070,00040%$27.1740,00060,00050%$26.3250,00050,00068PriceperSharevs.Leverage#OptimalCapitalStructurewd=30%gives:HighestcorporatevalueLowestWACCHigheststockpricepershareButwd=40%isclose.Optimalrangeisprettyflat.69OptimalCapitalStructurewd=Chapter16CapitalStructureDecisions70Chapter16CapitalStructureDeTopicsinChapterOverviewandpreviewofcapitalstructureeffectsBusinessversusfinancialriskTheimpactofdebtonreturnsCapitalstructuretheory,evidence,andimplicationsformanagersExample:Choosingtheoptimalstructure71TopicsinChapterOverviewandBasicDefinitionsV=valueoffirmFCF=freecashflowWACC=weightedaveragecostofcapitalrsandrdarecostsofstockanddebtreandwdarepercentagesofthefirmthatarefinancedwithstockanddebt.72BasicDefinitionsV=valueofHowcancapitalstructureaffectvalue?V=∑∞t=1FCFt(1+WACC)tWACC=wd(1-T)rd+wers73HowcancapitalstructureaffeAPreviewofCapitalStructureEffectsTheimpactofcapitalstructureonvaluedependsupontheeffectofdebton:WACCFCF(Continued…)74APreviewofCapitalStructureTheEffectofAdditional

DebtonWACCDebtholdershaveapriorclaimoncashflowsrelativetostockholders.Debtholders’“fixed”claimincreasesriskofstockholders’“residual”claim.Costofstock,rs,goesup.Firm’scandeductinterestexpenses.ReducesthetaxespaidFreesupmorecashforpaymentstoinvestorsReducesafter-taxcostofdebt(Continued…)75TheEffectofAdditional

DebtTheEffectonWACC(Continued)DebtincreasesriskofbankruptcyCausespre-taxcostofdebt,rd,toincreaseAddingdebtincreasepercentoffirmfinancedwithlow-costdebt(wd)anddecreasespercentfinancedwithhigh-costequity(we)NeteffectonWACC=uncertain.(Continued…)76TheEffectonWACC(Continued)TheEffectofAdditionalDebtonFCFAdditionaldebtincreasestheprobabilityofbankruptcy.Directcosts:Legalfees,“fire”sales,etc.Indirectcosts:Lostcustomers,reductioninproductivityofmanagersandlineworkers,reductionincredit(i.e.,accountspayable)offeredbysuppliers(Continued…)77TheEffectofAdditionalDebtImpactofindirectcostsNOPATgoesdownduetolostcustomersanddropinproductivityInvestmentincapitalgoesupduetoincreaseinnetoperatingworkingcapital(accountspayablegoesupassupplierstightencredit).(Continued…)78Impactofindirectcosts(ContiAdditionaldebtcanaffectthebehaviorofmanagers.Reductionsinagencycosts:debt“pre-commits,”or“bonds,”freecashflowforuseinmakinginterestpayments.Thus,managersarelesslikelytowasteFCFonperquisitesornon-valueaddingacquisitions.Increasesinagencycosts:debtcanmakemanagerstoorisk-averse,causing“underinvestment”inriskybutpositiveNPVprojects.(Continued…)79AdditionaldebtcanaffecttheAsymmetricInformation

andSignalingManagersknowthefirm’sfutureprospectsbetterthaninvestors.Managerswouldnotissueadditionalequityiftheythoughtthecurrentstockpricewaslessthanthetruevalueofthestock(giventheirinsideinformation).Hence,investorsoftenperceiveanadditionalissuanceofstockasanegativesignal,andthestockpricefalls.80AsymmetricInformation

andSiBusinessrisk:Uncertaintyaboutfuturepre-taxoperatingincome(EBIT).ProbabilityEBITE(EBIT)0LowriskHighriskNotethatbusinessriskfocusesonoperatingincome,soitignoresfinancingeffects.81Businessrisk:UncertaintyaboFactorsThatInfluenceBusinessRiskUncertaintyaboutdemand(unitsales).Uncertaintyaboutoutputprices.Uncertaintyaboutinputcosts.Productandothertypesofliability.Degreeofoperatingleverage(DOL).82FactorsThatInfluenceBusinesWhatisoperatingleverage,andhowdoesitaffectafirm’sbusinessrisk?OperatingleverageisthechangeinEBITcausedbyachangeinquantitysold.Thehighertheproportionoffixedcostswithinafirm’soverallcoststructure,thegreatertheoperatingleverage.(More...)83Whatisoperatingleverage,anHigheroperatingleverageleadstomorebusinessrisk:smallsalesdeclinecausesalargerEBITdecline.(More...)Sales$Rev.TCFQBEEBIT}$Rev.TCFQBESales84HigheroperatingleverageleadOperatingBreakevenQisquantitysold,Fisfixedcost,Visvariablecost,TCistotalcost,andPispriceperunit.Operatingbreakeven=QBEQBE=F/(P–V)Example:F=$200,P=$15,andV=$10:QBE=$200/($15–$10)=40.(More...)85OperatingBreakevenQisquantiProbabilityEBITLLowoperatingleverageHighoperatingleverageEBITHHigheroperatingleverageleadstohigherexpectedEBITandhigherrisk.86ProbabilityEBITLLowoperatingBusinessRiskversusFinancialRiskBusinessrisk:UncertaintyinfutureEBIT.Dependsonbusinessfactorssuchascompetition,operatingleverage,etc.Financialrisk:Additionalbusinessriskconcentratedoncommonstockholderswhenfinancialleverageisused.Dependsontheamountofdebtandpreferredstockfinancing.87BusinessRiskversusFinancialConsiderTwoHypotheticalFirmsFirmUFirmLNodebt $10,000of12%debt$20,000inassets$20,000inassets40%taxrate 40%taxrateBothfirmshavesameoperatingleverage,businessrisk,andEBITof$3,000.Theydifferonlywithrespecttouseofdebt.88ConsiderTwoHypotheticalFirmImpactofLeverageonReturnsFirmUFirmLEBIT $3,000$3,000Interest

01,200EBT $3,000$1,800Taxes(40%)1,200720NI $1,800$1,080ROE9.0%10.8%89ImpactofLeverageonReturnsFWhydoesleveragingincreasereturn?MoreEBITgoestoinvestorsinFirmL.Totaldollarspaidtoinvestors:U:NI=$1,800.L:NI+Int=$1,080+$1,200=$2,280.Taxespaid:U:$1,200;L:$720.Equity$proportionallylowerthanNI.90WhydoesleveragingincreaserContinued…NowconsiderthefactthatEBITisnotknownwithcertainty.WhatistheimpactofuncertaintyonstockholderprofitabilityandriskforFirmUandFirmL?91Continued…NowconsiderthefacFirmU:UnleveragedEconomyBadAvg.GoodProb.0.250.500.25EBIT$2,000$3,000$4,000Interest000EBT$2,000$3,000$4,000Taxes(40%)8001,2001,600NI$1,200$1,800$2,40092FirmU:UnleveragedEconomyBadAFirmL:LeveragedEconomyBadAvg.GoodProb.*0.250.500.25EBIT$2,000$3,000$4,000Interest1,2001,2001,200EBT$800$1,800$2,800Taxes(40%)3207201,120NI$480$1,080$1,680*sameasforFirmU93FirmL:LeveragedEconomyBadAvgFirmUBadAvg.GoodBEP10.0%15.0%20.0%ROIC6.0%9.0%12.0%ROE6.0%9.0%12.0%TIEn.a.n.a.n.a.FirmLBadAvg.GoodBEP10.0%15.0%20.0%ROIC6.0%9.0%12.0$ROE4.8%10.8%16.8%TIE1.7x2.5x3.3x94FirmUBadAvg.GoodBEP10.0%15.0ProfitabilityMeasures:ULE(BEP)15.0%15.0%E(ROIC)9.0%9.0%E(ROE)9.0%10.8%RiskMeasures:σROIC2.12%2.12%σROE2.12%4.24%95ProfitabilityMeasures:ULE(BEPConclusionsBasicearningpower(EBIT/TA)andROIC(NOPAT/Capital=EBIT(1-T)/TA)areunaffectedbyfinancialleverage.LhashigherexpectedROE:taxsavingsandsmallerequitybase.LhasmuchwiderROEswingsbecauseoffixedinterestcharges.Higherexpectedreturnisaccompaniedbyhigherrisk.(More...)96ConclusionsBasicearningpowerInastand-alonerisksense,FirmL’sstockholdersseemuchmoreriskthanFirmU’s.UandL:σROIC=2.12%.U:σROE=2.12%.L:σROE=4.24%.L’sfinancialriskisσROE-σROIC=4.24%-2.12%=2.12%.(U’siszero.)(More...)97Inastand-alonerisksense,FForleveragetobepositive(increaseexpectedROE),BEPmustbe>rd.Ifrd>BEP,thecostofleveragingwillbehigherthantheinherentprofitabilityoftheassets,sotheuseoffinancialleveragewilldepressnetincomeandROE.Intheexample,E(BEP)=15%whileinterestrate=12%,soleveraging“works.”98Forleveragetobepositive(iCapitalStructureTheoryMMtheoryZerotaxesCorporatetaxesCorporateandpersonaltaxesTrade-offtheorySignalingtheoryPeckingorderDebtfinancingasamanagerialconstraintWindowsofopportunity99CapitalStructureTheoryMMtheMMTheory:ZeroTaxesMMprove,underaveryrestrictivesetofassumptions,thatafirm’svalueisunaffectedbyitsfi