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Dr Charlene Lee (李丹

)

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I. Review of the Modigliani & Miller theorems
II. Valuation methods commonly used in
practice
III. Relation between R0 and RWACC
IV. Exercises

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The value of a firm is a linearly increasing function of its outstanding debt. where VL/VU denotes for the value of the levered/unlevered firm. 3 .Proposition I: VL = VU + TCB. and B denotes for the book value of debt. TC is the corporate tax rate.

Refer to MMI. Why is TCB the value of “tax shield”? 4 .

and the costs of capital premium of unlevered equity over debt. The cost of equity capital is a linear function of the debt to equity ratio. the netof-tax rate.RB). 5 . where RS /R0 denotes for the cost of equity for the levered/unlevered firm. and RB is the (before tax) cost of debt. SL is the value of levered equity.Proposition II: RS = R0 + (B / SL) × (1-TC) × (R0 .

Refer to MMII. and RB in a descending order? 6 . Can you sort RS. R0.

debt where UCF denotes for the unlevered CFs. 7 . Adjusted Present Value Approach: APV = NPV + NPVF Net Present Value of Financing Side Effects APV N t 1 UCFt (1 R0 )t Initial investment Additional effects of .1.

debt where UCF denotes for the unlevered CFs. 8 . Adjusted Present Value Approach APV = NPV + NPVF APV N t 1 UCFt (1 R0 )t Initial investment Additional effects of .1.

How do you compare APV with MMI? APV N t 1 UCFt (1 R0 )t Initial investment Additional effects of debt MMI (with taxes): VL = VU + TCB 9 .

Q: Then why do we need to learn other valuation methods.2. such as APV? 10 . WACC Approach NPVWACC N t 1 UCFt (1 RWACC )t Initial investment It’s the most popular method in practice.

3. 11 . investment borrowed where LCF denotes for the levered CFs. Note: I will require you to calculate UCF and LCF by using I/S if we have spare time. Flow to equity approach FTE N t 1 LCFt (1 RS )t Initial Amount .

3. 12 . Flow to equity approach FTE N t 1 LCFt (1 RS )t Initial Amount investment borrowed It’s more suitable for highly-levered firms/projects.

13 .RWACC RWACC R 0 (1-TC B S B ) It’s useful when you have the info for R0 at hand.

Check: Which three methods? Structure 1: zero debt Structure 2: 25% debt Structure 3: 50% debt 14 .An existing perpetual project under which the evaluations are the same by using three methods.

What are the features of an existing perpetual project? In terms of: Cash flows? Depreciation expenses? Capital investments? NWC investments? 15 .

Which structure has the highest corporate value? Possible to compare rates used in these methods with accounting ratios? Rates derived from CAPM? 16 .

Is WACC method the simplest one to use in evaluation? How about MMI method (with taxes)? Then why is WACC method most popular in practice? 17 .

On March 3. Beazer Plc. and Shearson Lehman Hutton. a British construction company. Inc... 1988. a producer of construction materials. 18 . Inc. and building products. (an investment banking firm). chemicals. commenced a hostile tender offer to purchase all the outstanding stock of Koppers Company.

19 . subsequently the offer was raised to $56. and then finally $61 per share.Originally the raiders offered $45 per share. The Koppers board generally asserted that the offers were inadequate and its management was reviewing the possibility of a major recapitalization.

000 at a pretax cost of debt of 10. Also assume that the proceeds of the loan would be paid as an extraordinary dividend to shareholders.5% and that the aggregate amount of debt will remain constant in perpetuity.Assume that Koppers could borrow a maximum of $1.095.738. 20 .

Fill out Exhibit 1 to present the changes in Koppers' book. Common equity 21 .and marketvalue balance sheets? Fixed assets. PV tax shield. Tax rate? Why do these items differ in book.and market-value balance sheets after the recapitalization.

Q1: What is the fair price for Koppers’ stock before and after the re-capitalization? Q2: If you were in the management. will you use this strategy to defend the hostile tender offer attempt? 22 .