Debt Policy and Value

EMBA 8500 1 bear measure of debt Book value of equity Market value of debt Market value of equity Pretax terms of debt After Tax cost of debt rd Market value weights of Wd Debt We Equity bL Levered beta Rf Risk-free cast Market Premium RM Ke Cost of equity WACC EBIT Taxes (34%) EBIAT + Depreciation Capital expense Change in solve Working Capital Free Cash Flow Value of Assets ( FCF/WACC) CASE 31 0% Debt speed of light% Equity $ $ 20,000 $ $ 20,000 7. 0% 4. 62% $ 34% $ $ $ $ $ $ 0 1 0. 8 7% 8. 6% 13. 88% 13. 88% 4,206. 00 1,430. 04 2,775. 96 1,000. 00 (1,000. 00) 0 2,775. 96 19,999. 1 25% Debt 75% Equity $ 5,000 $ 15,000 $ 5,000 $ 16,700 7. 0% 4. 62% 12/2/2012 50% Debt 1) As the firm becomes more leveraged the WACC will change because debtholders have a 50% Equity fixed claim on cash which increases the guess for armoryholders. This can cause the stock to go up $ 10,000 and firms can reduce the taxes paid, thereby freeing up more cash. Debt also increases the risk $ 10,000 of bankruptcy. $ 10,000 $ 13,400 (Debt * Tax Rate) + BV Equity 7. 0% 4. 62% (Pretax * (1-Tax Rate)) 23. 0% 42. 7% 77. 0% 57. 3% 0. 96 1. 19 7% 7% 8. 6% 8. 6% 15. 24% 17. 27% 12. 79% 11. 6% $ 4,206. 00 $ 4,206. 00 $ 1,430. 04 $ 1,430. 04 $ 2,775. 96 $ 2,775. 96 $ 1,000. 00 $ 1,000. 00 $ (1,000. 00) $ (1,000. 00) 0 0 $ 2,775. 96 $ 2,775. 96 $ 21,699. 69 $ 23,399. 66 Added Tax Shield increase value VL = VU + TD MV Debt / (MV Debt + MV Equity) MV Equity / (MV Debt + MV Equity) 0. 8 is the b u b L = b u 1+(1-T) * D/E HAMADA D/E Ratio 29. 94% 74. 63% Ke = Rf + (b L * RM) CAPM WACC = (Wd * rd) + (We * re) EBIT * Tax Rate EBIT Tax amount V = FCF/WACC M3DISK Maryann Albert, Mike Arendosh, Mark Jarboe, Dan Pool, Ivo Hegelbach, Sean McPherson, Krista Massell 1