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- 2. FIN 591: Financial Fundamentals/Valuation M&M: The Starting Point A number of restrictive assumptions apply Use the
- 3. FIN 591: Financial Fundamentals/Valuation The M&M Assumptions Homogeneous expectations Homogeneous business risk (σEBIT) classes Perpetual no-growth
- 4. FIN 591: Financial Fundamentals/Valuation Business Risk Business risk: Risk surrounding expected operating cash flows Factors causing
- 5. FIN 591: Financial Fundamentals/Valuation Principle of Additivity Allows you to value the cash flows in any
- 6. FIN 591: Financial Fundamentals/Valuation Additivity Example Market risk premium = 8%; risk-free rate = 6% RADR
- 7. FIN 591: Financial Fundamentals/Valuation M&M Capital Structure Propositions (No Taxes) M&M Proposition I: Value of unlevered
- 8. FIN 591: Financial Fundamentals/Valuation M&M Propositions I & II (No Taxes) Investment Alternative Initial investment =
- 9. FIN 591: Financial Fundamentals/Valuation M&M Propositions I & II (No Taxes) Proposition I: VL = VU
- 10. FIN 591: Financial Fundamentals/Valuation Graphing the M&M No-Tax Relationships Firm value (Proposition I) VU VL Debt
- 11. FIN 591: Financial Fundamentals/Valuation M&M Capital Structure Propositions (Corporate Taxes) M&M Proposition I: VL = VU
- 12. FIN 591: Financial Fundamentals/Valuation M&M Propositions I & II (Corporate Taxes) Investment and financing alternatives -
- 13. FIN 591: Financial Fundamentals/Valuation Tax Benefit of Debt Financing Debt interest is tax deductible For every
- 14. FIN 591: Financial Fundamentals/Valuation A Look at the Propositions Proposition I: VL = VU + τC
- 15. FIN 591: Financial Fundamentals/Valuation Confirmation VL = B + S = rb B / rb +
- 16. FIN 591: Financial Fundamentals/Valuation Graphing the M&M Relationships Firm value (Proposition I) VL Slope = τc
- 17. FIN 591: Financial Fundamentals/Valuation Another Look with Corporate Taxes Market Value Balance Sheet (All equity firm)
- 18. FIN 591: Financial Fundamentals/Valuation An Aside: Introducing Personal Taxes Miller (1977) suggests that debt has both
- 19. FIN 591: Financial Fundamentals/Valuation Miller’s Argument VL = VU + [1 - (1 - τc)(1 -
- 20. FIN 591: Financial Fundamentals/Valuation Net Tax Advantage PV of net tax advantage (NTA) of perpetual debt:
- 21. FIN 591: Financial Fundamentals/Valuation Changing the Rates Suppose shareholders can defer taxes, thereby lowering the effective
- 22. FIN 591: Financial Fundamentals/Valuation How Does NTA Affect M&M Model? M&M: VL = VU + τc
- 23. FIN 591: Financial Fundamentals/Valuation A Graphical View of Miller Value Vu Debt (B) VL = VU
- 24. FIN 591: Financial Fundamentals/Valuation Relationship Between Firm Value and WACC Value of firm = Value of
- 25. FIN 591: Financial Fundamentals/Valuation WACC: An Earning Power View Assumptions: Maintain current level of production and
- 26. FIN 591: Financial Fundamentals/Valuation WACC: A Financing View Calculate the cost of: Debt Preferred stock Common
- 27. FIN 591: Financial Fundamentals/Valuation Debt’s Yield to Maturity Example: 14s of December 2014 selling for 110
- 28. FIN 591: Financial Fundamentals/Valuation A Graphical View: YTM Semiannual interest rate (r) $2,610 $2,000 $1,100 $1,000
- 29. FIN 591: Financial Fundamentals/Valuation Cost of Debt Cost of debt to the firm is the YTM
- 30. FIN 591: Financial Fundamentals/Valuation Cost of Debt = YTM * (1 - τc) Represents a good
- 31. FIN 591: Financial Fundamentals/Valuation Cost of Preferred Stock Preferred stock dividend is not tax deductible Cost
- 32. FIN 591: Financial Fundamentals/Valuation Cost of Equity Cost of equity is more difficult to calculate than
- 33. FIN 591: Financial Fundamentals/Valuation Using Historic Returns Estimating cost of capital using past returns is justified
- 34. FIN 591: Financial Fundamentals/Valuation Dividend Growth Model re = D1 / P0 + g = D0
- 35. FIN 591: Financial Fundamentals/Valuation Growth Rate Arithmetic return: Simple average of historical returns Geometric return: [(1
- 36. FIN 591: Financial Fundamentals/Valuation Equity Cost Using the Dividend Growth Model Price = Expected dividend next
- 37. FIN 591: Financial Fundamentals/Valuation P/E and Cost of Equity Dividend growth model: re = D1 /
- 38. FIN 591: Financial Fundamentals/Valuation Problem with Dividend Model Says nothing about risk! Returns should be based
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