Professional Documents
Culture Documents
CHAPTER 13
Capital Structure and Leverage
High risk
0 E(EBIT) EBIT
Note that business risk does not include
financing effects.
Copyright © 2002 by Harcourt, Inc. All rights reserved.
13 - 3
EBITL EBITH
Firm U Firm L
No debt $10,000 of 12% debt
$20,000 in assets $20,000 in assets
40% tax rate 40% tax rate
Both firms have same operating
leverage, business risk, and probability
distribution of EBIT. Differ only with
respect to use of debt (capital structure).
Copyright © 2002 by Harcourt, Inc. All rights reserved.
13 - 10
Firm U: Unleveraged
Economy
Bad Avg. Good
Prob. 0.25 0.50 0.25
EBIT $2,000 $3,000 $4,000
Interest 0 0 0
EBT $2,000 $3,000 $4,000
Taxes (40%) 800 1,200 1,600
NI $1,200 $1,800 $2,400
Copyright © 2002 by Harcourt, Inc. All rights reserved.
13 - 11
Firm L: Leveraged
Economy
Bad Avg. Good
Prob.* 0.25 0.50 0.25
EBIT* $2,000 $3,000 $4,000
Interest 1,200 1,200 1,200
EBT $ 800 $1,800 $2,800
Taxes (40%) 320 720 1,120
NI $ 480 $1,080 $1,680
*Same as for Firm U.
Copyright © 2002 by Harcourt, Inc. All rights reserved.
13 - 12
8
TIE
Expected Values:
U L
E(BEP) 15.0% 15.0%
E(ROE) 9.0% 10.8%
8
E(TIE) 2.5x
Risk Measures:
sROE 2.12% 4.24%
CVROE 0.24 0.39
Conclusions
EBIT
TIE = .
Int
($400,000)(0.6)
= 80,000 = $3.00.
Copyright © 2002 by Harcourt, Inc. All rights reserved.
13 - 22
D = $250, kd = 8%.
Shares $250,000
repurchased = = 10,000.
$25
[$400 – 0.08($250)](0.6)
EPS1 =
80 – 10
= $3.26.
EBIT $400
TIE = = = 20×.
I $20
Copyright © 2002 by Harcourt, Inc. All rights reserved.
13 - 23
D = $500, kd = 9%.
Shares $500
repurchased = = 20.
$25
[$400 – 0.09($500)](0.6)
EPS2 =
80 – 20
= $3.55.
EBIT $400
TIE = = = 8.9×.
I $45
Copyright © 2002 by Harcourt, Inc. All rights reserved.
13 - 24
D = $750, kd = 11.5%.
Shares $750
repurchased = = 30.
$25
[$400 – 0.115($750)](0.6)
EPS3 =
80 – 30
= $3.77.
EBIT $400
TIE = = = 4.6×.
I $86.25
Copyright © 2002 by Harcourt, Inc. All rights reserved.
13 - 25
D = $1,000, kd = 14%.
Shares $1,000
repurchased = = 40.
$25
[$400 – 0.14($1,000)](0.6)
EPS4 =
80 – 40
= $3.90.
EBIT $400
TIE = = = 2.9×.
I $140
Copyright © 2002 by Harcourt, Inc. All rights reserved.
13 - 26
D1 EPS DPS
P0 = = = .
ks – g ks ks
bL = bU[1 + (1 – T)(D/E)].
15 ks
WACC
kd(1 – T)
P0
EPS
D/A
.25 .50
Copyright © 2002 by Harcourt, Inc. All rights reserved.
13 - 39
If it were discovered that the firm had
more/less business risk than originally
estimated, how would the analysis be
affected?
1. Sales stability?
2. High operating leverage?
3. Increase in the corporate tax rate?
4. Increase in the personal tax rate?
5. Increase in bankruptcy costs?
6. Management spending lots of
money on lavish perks?
Copyright © 2002 by Harcourt, Inc. All rights reserved.
13 - 42
Value of Stock
MM result
Actual
No leverage
D/A
0 D1 D2
Assumptions: