Not covered in class

Debt fixed
EBIT 1485 1485
Tc 0.34 0.34
r0 0.098 0.098
VU 10,000 10,000
B 2500 -
L - 0.25
Wacc 9.03% 8.97%
V 10,850 10,930
VTS 850 930
S 10,000 8,198
B 2,500 2,733
Intro
An Introduction to Debt Policy and Value
This case illustrates 3 different approaches to value a levered firm.
Be aware of the assumptions underlying the formulas: CONSTANT PERPETUITIES & RISKLESS DEBT
Q1 Discount unlevered FCF at the WACC
Q2 Value equity and debt separately
Q3 Add the present value of tax shields to
the value of the unlevered firm
Page 3
Intro
An Introduction to Debt Policy and Value
This case illustrates 3 different approaches to value a levered firm.
Be aware of the assumptions underlying the formulas: CONSTANT PERPETUITIES & RISKLESS DEBT
Page 4
Q1
Value of assets 0% Debt 25%Debt 50% Debt
100% Equity 75% Equity 50% Equity
Book value of debt - 2,500 5,000
Book value of equity 10,000 7,500 5,000
Market value of debt - 2,500 5,000
Market value of equity 10,000 8,350 6,700
Pretax cost of debt 0.05 0.05 0.05
After-tax cost of debt 0.0330 0.0330 0.0330
Market value weights of
Debt 0.00% 23.04% 42.74%
Equity 100.00% 76.96% 57.26%
Unlevered beta 0.8 0.8 0.8
Risk-free rate 0.05 0.05 0.05
Market premium 0.06 0.06 0.06
Levered beta 0.8 0.96 1.19
Cost of equity 9.80% 10.75% 12.16%
WACC 9.80% 9.03% 8.38%
EBIT 1,485 1,485 1,485
-Taxes (34%) 505 505 505
EBIAT 980 980 980
+ Depreciation 500 500 500
- Capital exp. 500 500 500
=Free cash flow 980 980 980
Value of assets 10,000 10,850 11,700
Tax rate 34%
Page 5
Q2
Value of financing
0% Debt 25%Debt 50% Debt
100% Equity 75% Equity 50% Equity
Cash flow to creditors 0 125 250
Pretax cost of debt 0.05 0.05 0.05
Value of debt - 2,500 5,000
Cash flow to stockholders
EBIT 1485 1485 1485
-Interest 0 125 250
Pretax profit 1485 1360 1235
Taxes (34%) 505 462 420
Net income 980 898 815
+ Depreciation 500 500 500
- Capital exp. 500 500 500
-Debt amortization 0 0 0
Residual cash flow 980 898 815
Cost of equity 9.80% 10.75% 12.16%
Value of equity 9,998 8,353 6,699
Value of company S+B 9,998 10,853 11,699
Page 6
Q3
0% Debt 25%Debt 50% Debt
100% Equity 75% Equity 50% Equity
Pure business cash flow
EBIT 1,485 1,485 1,485
Taxes 505 505 505
EBIAT 980 980 980
+Depreciation 500 500 500
-Capital exp. 500 500 500
Cash flow 980 980 980
Unlevered beta 0.8 0.8 0.8
Risk-free rate 0.05 0.05 0.05
Market risk premium 0.06 0.06 0.06
Unlevered WACC 9.80% 9.80% 9.80%
Value of pure business 10,000 10,000 10,000
Financing cash flows
Interest - 125.00 250.00
Tax reduction - 42.50 85.00
Pretax cost of debt 0.05 0.05 0.05
Value of financing effect - 850 1,700
Total value 10,000 10,850 11,700
Page 7
Q4
0% Debt 25%Debt 50% Debt
100% Equity 75% Equity 50% Equity
Initial mkt value of equity 10,000 10,000 10,000
PVTS 0 850 1,700
Mkt value of equity
after announcement 10,000 10,850 11,700
Initial # shares 1,000 1,000 1,000
Price per share 10.00 10.85 11.70
after announcement
Cash paid out 0 2,500 5,000
Market value of equity 10,000 8,350 6,700
# of shares repurchased 0 230 427
# shares after repurchase 1,000 770 573
Share price 10.00 10.85 11.70
Page 8
Koppers Company
Koppers Company, Inc.
Before After
Recapitalization Recapitalization
New borrowing 1,565,686
Book-Value Balance Sheets:
Net working capital 212,453 212,453
Fixed assets 601,446 601,446
Total assets 813,899 813,899
Long-term debt 172,409 1,738,095
Deferred taxes, etc.. 195,616 195,616
Preferred stock 15,000 15,000
Common equity 430,874 -1,134,812
Total capital 813,899 813,899
Market-Value Balance Sheets:
Net working capital 212,453 212,453
Fixed assets 1,618,081 1,618,082
PV debt tax shield 58,619 590,952
Total assets 1,889,153 2,421,487
Long-term debt 172,409 1,738,095
Deferred taxes, etc.. 0 0
Preferred stock 15,000 15,000
Common equity 1,701,744 668,392
Total capital 1,889,153 2,421,487
Number of shares 28,128 28,128
Price per share 60.50 23.76
Value to Public Shareholders
Cash received 0 1,565,686
Value of shares 1,701,744 668,392
Total 1,701,744 2,234,078
Total per share 60.50 79.43