...problem 2, we calculated the total value per share when firm borrows money to repurchase shares. From the calculation below, we can see that total market value of equity declined from 10,000 to 6,700, while total value per share rose from $10 to $11.70. Therefore, as the firm borrows and repurchases shares, the total value of equity declined, but the price per share rose. Assume that all the new debt is used to repurchase shares. Share price = (Total market value of equity + Cash paid out)/ Number of original shares Based on this assumption change, we will go through all the calculations one more time and estimate the impact of this change across the board. The table 5.1 contains various cost of debts based on various capital structures. In this table we estimate value of operations, value of debt, value of equity, stock price, net income and earnings per share of the firm for various capital structures. Our objective here is to identify the optimum capital structure for the firm. {draw:frame} Table 5.1 – Cost of Debt for various Capital Structures We used the Hamada equation to estimate the impact of the financial leverage on beta. This calculation is done in the table 5.2. The leveraged beta is utilized to estimate the true weighted average cost of capital (WACC) for various capital structures. Table 5.2 estimated the cost of equity, leveraged beta, weighted average cost of capital, free cash flow and the value of the assets for various capital...
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...Credit Cards, Excess Debt, and the Time Value of Money: The Parable of the Debt Banana Timothy Falcon Crack and Helen Roberts University of Otago, New Zealand The parable of the debt banana is an analogy between the accumulation of excess personal debt and the accumulation of excess body weight. We created this parable to grab student attention and to then serve as a springboard for discussion of personal debt, time value of money mathematics, the mechanics of credit cards, personal bankruptcy, moral hazard, ethics, and credit card reform. A follow-up survey in a large class (453 students; 84% response rate) showed that 92% of students seeing the parable alongside the underlying finance principles said that it grabbed their attention more than if the underlying finance principles alone were presented, and 87% of students said it made an impression upon them that will make them more careful in their future credit card spending habits. We provide worked examples of credit card use as well as a spreadsheet that lets readers explore these examples and perform sensitivity analysis. INTRODUCTION The parable of the debt banana is an analogy between the accumulation of excess personal debt and the accumulation of excess body weight. We created and presented our parable in a compulsory Finance 101 course taken by all business majors. Most students had little or no exposure to the world of finance and many had poor mathematical skills. Both their lack of financial...
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...recapture. c. the weighted average cost of capital. d. private debt placement. e. personal offset. Difficulty level: Easy MM PROPOSITION I b 2. The proposition that the value of the firm is independent of its capital structure is called: a. the capital asset pricing model. b. MM Proposition I. c. MM Proposition II. d. the law of one price. e. the efficient markets hypothesis. Difficulty level: Easy MM PROPOSITION II c 3. The proposition that the cost of equity is a positive linear function of capital structure is called: a. the capital asset pricing model. b. MM Proposition I. c. MM Proposition II. d. the law of one price. e. the efficient markets hypothesis. Difficulty level: Medium INTEREST TAX SHIELD a 4. The tax savings of the firm derived from the deductibility of interest expense is called the: a. interest tax shield. b. depreciable basis. c. financing umbrella. d. current yield. e. tax-loss carryforward savings. Difficulty level: Easy 15-1 UNLEVERED COST OF CAPITAL b 5. The unlevered cost of capital is: a. the cost of capital for a firm with no equity in its capital structure. b. the cost of capital for a firm with no debt in its capital structure. c. the interest tax shield times pretax net income. d. the cost of preferred stock for a firm with equal parts debt and common stock in its capital structure. e. equal to the profit margin for a firm with some debt in its capital structure. Difficulty level: Easy WEIGHTED AVERAGE...
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...1. Discuss the signaling effects for a firm associated with increasing leverage or implementing a stock repurchase. Increasing leverage is increasing debt of the firm. Leverage is associated with net income/EBIT. In general the higher this ratio the higher the risk because in good times higher leverage gives better results but on the the other hand in bad times high leverage causes problems, because increase in leverage will cause an increase of the beta of the firm. Moreover leverage increases Earnings per share, but still creates risk. Modigliani and Miller says that no capital structure is better than the other because this doesn’t change the total value of the outstanding shares by changing the capital structure. But the required return will be higher since leverage increases risk. As for stock repurchase, instead of paying dividend company may choose stock repurchase. There are 3 ways. First one is , companies may simply purchase their own stock, just like an investor buying in the market. In these open market purchases , the firm’s name is not given as the buyer. So , the one who sells the stock does not know whether the shares were sold back to the firm or to another investor. Secondly , tender offer is another way in which the firm makes a call to its stockholders that it has an intention of buying a fixed number of shares at a pre-determined price. As the last one firm may prefer to buy from specific investor and this process is known as targeted purchase. It...
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...or has lower debt component, it has no bearing on its market value. Rather, the market value of a firm is dependent on the operating profits of the company. Capital structure of a company is the way a company finances its assets. A company can finance its operations by either debt or equity or different combinations of these two sources. Capital structure of a company can have majority of debt component or majority of equity, only one of the 2 components or an equal mix of both debt and equity. Each approach has its own set of advantages and disadvantages. There are various capital structure theories, trying to establish a relationship between the financial leverage of a company (the proportion of debt in the company's capital structure) with its market value. One such approach is the Modigliani and Miller Approach. This approach was devised by Modigliani and Miller during 1950s. The fundamentals of Modigliani and Miller Approach resemble to that of Net Operating Income Approach. Modigliani and Miller advocates capital structure irrelevancy theory. This suggests that the valuation of a firm is irrelevant to the capital structure of a company. Whether a firm is highly leveraged or has lower debt component in the financing mix, it has no bearing on the value of a firm. Modigliani and Miller Approach further states that the market value of a firm is affected by its future growth prospect apart from the risk involved in the investment. The theory stated that value of the firm is...
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...econstor www.econstor.eu Der Open-Access-Publikationsserver der ZBW – Leibniz-Informationszentrum Wirtschaft The Open Access Publication Server of the ZBW – Leibniz Information Centre for Economics Faulkender, Michael; Petersen, Mitchell A. Working Paper Does the source of capital affect capital structure? CSIO working paper, No. 0054 Provided in Cooperation with: Department of Economics - Center for the Study of Industrial Organization (CSIO), Northwestern University Suggested Citation: Faulkender, Michael; Petersen, Mitchell A. (2004) : Does the source of capital affect capital structure?, CSIO working paper, No. 0054 This Version is available at: http://hdl.handle.net/10419/38692 Nutzungsbedingungen: Die ZBW räumt Ihnen als Nutzerin/Nutzer das unentgeltliche, räumlich unbeschränkte und zeitlich auf die Dauer des Schutzrechts beschränkte einfache Recht ein, das ausgewählte Werk im Rahmen der unter → http://www.econstor.eu/dspace/Nutzungsbedingungen nachzulesenden vollständigen Nutzungsbedingungen zu vervielfältigen, mit denen die Nutzerin/der Nutzer sich durch die erste Nutzung einverstanden erklärt. zbw Leibniz-Informationszentrum Wirtschaft Leibniz Information Centre for Economics Terms of use: The ZBW grants you, the user, the non-exclusive right to use the selected work free of charge, territorially unrestricted and within the time limit of the term of the property rights according to the terms specified at → http://www.econstor.eu/dspace/Nutzungsbedingungen...
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...asymmetric information, an in an efficient market, the value of a firm is unaffected by how the firm is financed. Whether the firm’s capital is raised by issuing stock or selling debt does not affect the value of the firm. This theory is also referred to as the capital structure irrelevance principle, which we have already looked at in previous seminar discussions. There are two propositions which were discussed by Modigliani and Miller. The first proposition states that the value if a firm does not depend on its capital structure. An example would be if two firms with the same business operations and similar kind of assets, where to be assessed after using either stocks or debt to finance the firm of s. On the left side their balance sheets, these firms will look the same, only difference being the right side, i.e. the liabilities and how they finance business activities. M&M proposition 1 therefore says that how the debt and equity is structured in a corporation is irrelevant as the value of the firm is determined by real assets and not its capital structure. Implications of this proposition firstly revolve around the issue of changing capital structure. Assuming that the three conditions identified by M&M apply and considering a company which is financed entirely with equity. The annual cash flows of R100, which are expected to continue forever, if an appropriate discount rate is 10%, we can calculate the value of the firm to perpetuity as PVA=100/0.1= R1000. Since...
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...not affect the value of the firm and we have to know the relationship between the capital structure and the firm’s value. We are try to learn the changes in capital structure that do not affected the firm’s value and want to know relationship between the capital structure and the value of firm. For this study we used five independent variable that are profitability , growth , leverages , size and intangible ratio on the other hand we have one dependent variable that are firm value. We collected data from the Karachi stock exchange (KSE) and State Bank of Pakistan. Contents CHAPTER 1: INTRODUCTION 4 1.1 Background of the study 4 1.2 Problem Statement 6 1.3 Purpose of the study 7 1.4 Significance of the study 7 1.5 Operational definitions of the variables 8 1.5.1 Leverage: 8 1.5.2 Market to Book Value: 8 1.5.3 Profitability: 8 1.5.4 Growth: 8 1.5.5 Size: 8 1.5.6 Intangible: 9 CHAPTER 2: LITERATURE REVIEWS 10 2.1 Theoretical Background: 10 2.2 Empirical evidence: 11 CHAPTER 3: METHODOLOGY 17 3.1 Research Method 17 3.2 Research Model 17 3.3 Research Hypothesis: 18 3.4 Data Collection 18 3.5 Population and Sample Size 18 3.6 Research Technique 19 INTRODUCTION * Background of the study The aim of every organization to adjust their long term and short term debt but mainly in this study it is focused on the long term debt that are occurred...
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...INTRODUCTION Beverly Flax and Rick Rosenfield founded California Pizza Kitchen in 1985 in Beverly Hills, California. California Pizza Kitchen is a casual dining, full service restaurant concept that specializes in gourmet pizzas with unique topping combinations. At the end of the second quarter of 2007 they operated 213 locations in 28 states and in 6 foreign countries. The company derives its revenue from three sources: sales at company-owned restaurants, royalties from franchised restaurant, and royalties from a partnership with Kraft Foods to sell California Pizza Kitchen branded frozen pizzas in grocery stores. Although the restaurant industry was going through some difficulties California Pizza Kitchen was really successful, and the quarterly profit was over $6 million, quite a record for the firm. Management believed that its success was due to its dedication to guest satisfaction and menu innovation and sustainable culture of service. A creative menu with high-quality ingredients was a top priority at California Pizza Kitchen. In addition to creating its inventive menu, California Pizza Kitchen had an average check of $13.3, which was below the one of many of its upscale dining casual peers. Also California Pizza Kitchen spent 1% of its sales on advertising, far less than the 3% or 4% spent by the competitors (for instance Olive Garden or Chilli’s Red Lobster) management felt that its attention to the clients and the innovative menus resulted in free but more valuable...
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...facilitate CPK’s success. Firstly, we know that CPK is very successful overseas with different locations opened internally. Thus, we suggest that they should continue their expansion to make CPK’s name known globally. With this idea in mind, we also noticed that they barely invested any of its sales on advertisement compared to other casual dining competitors. Advertisement by using the media is highly effective for promotion in today’s society. Not limited to TVs and magazines, but using the social media like Facebook and Twitter to spread between friends or even promote with Groupon and Livings Social to give special discounts and attract new customers. Another way may be repurchasing shares from investors. This, however, will have to add debt, which goes against co-CEO...
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...CCI The motor carrier industry is highly regulated, resulting with high level of financial stability. Through government regulations, more specifically from the U.S Interstate Commerce Commission (ICC), Continental Carriers and others have received steady financial resource allocations and maintained steadily increasing profits with minimal fluctuations over the years. In addition, with the government’s tight entry control, the industry is able to create a high market entry barrier to prevent new entrants from gaining market shares. On top of that, rate regulations have helped prevent destructive competitions within the industry. Traditionally, Continental Carriers has maintained a consistent policy of avoiding long-term debts or any type of fixed debts, and it has financed itself through retained earnings along with proceeds of its previous stock offering and short-term bank loans, which do not occur often. More importantly, since most of the common stock is held by the management itself, CCI is able to maintain more control over financial decisions. These as a whole have contributed to its current economic state of steady increase in income and dividends per share (from 1$ to 1.5$ per share). Nevertheless, one of the financial problems that CCI currently encounters is the subpar performance of company’s common stock. Although the operating revenue and income per share have both been steadily increasing, the average market price of common stock nonetheless experienced a decrease...
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...several reasons: 1. Low debt levels: a. Leverage Ratio = 4.61% (LT Debt/Total Assets) b. Interest Coverage = 40x (EBIT/Interest Expense) 2. Excess cash on hand: $95.1 million 3. Good stability of business operations resulting in stable earnings and cashflows going forward, further enforced by patents. 4. No major capital requirements to continue business operations. 5. Sound asset base that can be used to raise debt as collateral . Overall Valuation Approach Since the leverage ratio for Congoleum will decrease over time as debt used to finance the purchase is repaid, we will use the APV approach rather than the WACC. APV Approach : Value of levered firm = Value of unlevered firm + PV of Int. Tax Shield 1. Assumptions & Approach A. Value of Unlevered Firm – i.e. value the company as if the company is all-equity financed. 1. Calculate cost of unlevered equity by de-leveraging the equity beta at 7% debt-to-capitalization ratio. Risk-free rate and market risk premium are given. (source: Exhibit 9) 2. Calculate the FCF to firm by using NOPLAT + Depreciation – Capex – net changes in WC (source: Exhibit 13) 3. Find sum of PV (FCF) for 1980-1984 4. Assume growth rate in FCF of 8%. This is a conservative estimate of the growth rate. (source: Inflation rate in 1987 was approximately 8%). 5. Find Terminal Value of FCF and then PV(Terminal Value of FCF) B. PV(ITS) 1. Calculate cost of debt using average of comparables...
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...to my client, the director of ABC Investment Group. Since the Director has a limited understanding the US GAAP regarding Debt security, therefore I have to be concise in my presentation. ABC Investment Group is an investment company, and they deal with debt security. Their main concerns are how to recognize and record the transaction on unrealized gains/losses in their holding debt securities, and when they should write down debt securities. The key to the problem lies on how the ACB Investment Group treat their investment. According to FASB ASC 320-10-25 the debt securities are classified in three groups as Trading Security (TD), Available For Sale (AFS), and Held To Maturity (HTM); and each class of debt investment has different accounting method to recording its transaction. Trading Security uses the Fair Value method in account for the gains/losses, and this debt security is the most active portfolio to the company because the objective of this portfolio is to generate profit in a short term by participating in the buying and selling of debt securities. When unrealized gains/losses for trading securities are recognized, they need to record as an earning in income statement, and trading securities will be treated as a current asset in the balance sheet of the company. Available For Sale (AFS): like trading security, AFV also use the Fair Value method in recognize any unrealized gains/losses as it occurs in the recording period. Unlike the trading security, Unrealized...
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...expects to expand its worldwide business base with new products and services as both companies have only 5 percent overlap in their product offerings. Timken will also be able to broaden its technology and engineering capabilities to enable it to deliver more value to customers around the globe; the two companies’ customer list overlaps by 80 percent. Thus it was expected that the combined companies would be able to create more value for customers with a more complete product line and, eventually more effective new-product development. Timken will move quickly to integrate Torrington into its global automotive and industrial business structures and expects to achieve estimated annualized savings of $80 million by the end of 2007. These savings are expected to come from economies of scale; consolidating purchasing activities and distribution channels, combining operations and eliminating redundancies within the organization. My first stand –alone valuation of Torrington is based on the DCF analysis method. First of all, Torrington’s parent company (Ingersoll-Rand)’s WACC needs to be calculated. A tax rate of 39% is assumed based on its historical information and leverage ratios of 37.6% is estimated based on the book value...
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