Ch-3: Intermediate term debt financing
NPVLOR= - Io + PVIFA (kd%,n yrs.) [Lt(1-T) +T*Deprn ]
Cost of leasing: PVIFA (kd%,nyrs.)Lt(1-T)
Cost of Owning: Io- PVIFA (kd%,nyrs.)[T.Dept +zn(1-T)]
NPV (Lease)or(NAL)= Cost of owning - cost of leasing.
Decision rule: If positive, leasing is preferred.
If negative, owning is preferred.
Where,
NAL: Net Advantage to Leasing
Kd: After tax cost of debt
NPVLOR: NPV to the lessor.
Io= cost of the asset
Dep = annual straight-line depreciation
Kb= before tax cost of debt
T= Corporate tax rate
n = economic life of asset
zn= salvage value
Internal rate of return method(IRR)
Decision rule:
IRR > Kd: Choose owning.
IRR < Kd: Choose leasing.
Chapter-4: Common Stock Financing
The nature of cumulative voting may be illustrated as under:
𝒅𝒅𝒅𝒅𝒅𝒅.(𝒏𝒏)
Req.= +1
∝ + 𝟏𝟏
Alternatively,
(𝒓𝒓𝒓𝒓𝒓𝒓 – 𝟏𝟏) (∝ +𝟏𝟏)
Des. =
𝒏𝒏
where,
req. = Number of shares required to elect a
desired number of directors.
des. = Desired number of directors to elect.
n = No. of common stocks outstanding.
∝ = Total number of directors to be elected.
𝑭𝑭𝑭𝑭𝑭𝑭𝑭𝑭𝑭𝑭 𝒕𝒕𝒕𝒕 𝒃𝒃𝒃𝒃 𝒓𝒓𝒓𝒓𝒓𝒓𝒓𝒓𝒓𝒓𝒓𝒓
No. of new shares=
𝑺𝑺𝑺𝑺𝑺𝑺𝑺𝑺𝑺𝑺𝑺𝑺𝑺𝑺𝑺𝑺𝑺𝑺𝑺𝑺𝑺𝑺𝑺𝑺 𝒑𝒑𝒑𝒑𝒑𝒑𝒑𝒑𝒑𝒑
𝑶𝑶𝑶𝑶𝑶𝑶 𝒔𝒔𝒔𝒔𝒔𝒔𝒔𝒔𝒔𝒔𝒔𝒔
No. of new rights=
𝑵𝑵𝑵𝑵𝑵𝑵 𝒔𝒔𝒔𝒔𝒔𝒔𝒔𝒔𝒔𝒔𝒔𝒔
𝑷𝑷𝑷𝑷−𝑷𝑷𝑷𝑷
Value of a right: Vr=
𝜶𝜶+𝟏𝟏
𝑷𝑷𝑷𝑷−𝑷𝑷𝑷𝑷
Ex-rights: Vr=
𝜶𝜶
Where,
Po=MPS, rights on price
Ps= Subs. price
𝜶𝜶 =No. of rights reqd.
Pe= MPS, ex rights
Effects on MPS & Total wealth
• After rights offering, MPS declines by a value of a right.
• stockholders will neither benefit nor lose by the rights offer-
ing.
𝑴𝑴𝑴𝑴𝑴𝑴
PE ratio=
𝑬𝑬𝑬𝑬𝑬𝑬
DPS= EPS*Dividend payment rate
𝑬𝑬𝑬𝑬𝑬𝑬𝑬𝑬
EPS=
𝑵𝑵𝑵𝑵 𝒐𝒐𝒐𝒐 𝒔𝒔𝒔𝒔𝒔𝒔𝒔𝒔𝒔𝒔
Chapter-5: Long Term Debt & Preferred Stock
Investment outlay required to refund the issued
Call Premium on old issue.
Flotation cost on new issue.
Tax saving on old issue flotation cost.
Extra interest cost on old issue.
Interest earned on short tearm investment.
Net Investment outlay
---------------------------------------------------------------------
Annual Flotation cost tax effect
Annual tax savings from new issues flotation costs.
Annual lost tax saving from old issues floatation costs.
PV of amortization tax effects.
---------------------------------------------------------------------
Saving due to refunding
Interest payment on old issue
Interest payments on new issue
Net interest savings
---------------------------------------------------------------------
NPV of refunding decision
---------------------------------------------------------------------
Chapter-6: Warrants & Convertibles
Warrents
Formula value (FV) = (MPS – OP) * α
Warrent Premium = Actual value (AV)- Formula value (FV)
Convertibles
Par value of bond
Conversion Ratio =
Conversion price
Conversion value(ct):Ct = Po (1+g)t x α
Straight Bond Value (Bt): Bt =PVIFA (i%, n yrs) c + PVIF (i%, n yr) M
Expected market value floor = BoXCt
Expected rate of return (IRR)
M= PVIFA(i%,n yrs) c + PVIF(i%, n yr) Ct
CI + Conv. Value - VB
-----------------------
n
IRR= -----------------------------------
Conv. Value + 2 (VB)
---------------------------
3
By interpolation,
Lr value- par value
IRR= LR IRR + ----------------------------------- (HR IRR-LR IRR)
Lr value - Hr value
Exchangeable Debt
Par value
Exchangeable ratio =
Exchange price
Chapter-8: Theory of Capital Structure
Three capitalization rates:
1. Debt capitalization rate (ki):
𝑨𝑨𝑨𝑨𝑨𝑨𝑨𝑨𝑨𝑨𝑨𝑨 𝒊𝒊𝒊𝒊𝒊𝒊𝒊𝒊𝒊𝒊𝒊𝒊𝒊𝒊𝒊𝒊 𝒄𝒄𝒄𝒄𝒄𝒄𝒄𝒄𝒄𝒄𝒄𝒄𝒄𝒄 (𝑭𝑭)
Ki=
𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴 𝒗𝒗𝒗𝒗𝒗𝒗𝒗𝒗𝒗𝒗 𝒐𝒐𝒐𝒐 𝒅𝒅𝒅𝒅𝒅𝒅𝒅𝒅 (𝑩𝑩)
2. Equity capitalization rate (ke):
𝑬𝑬𝑬𝑬𝑬𝑬𝑬𝑬𝑬𝑬𝑬𝑬𝑬𝑬𝑬𝑬 𝒕𝒕𝒕𝒕 𝒄𝒄𝒄𝒄𝒄𝒄.𝒔𝒔𝒔𝒔𝒔𝒔𝒔𝒔𝒔𝒔𝒔𝒔𝒔𝒔𝒔𝒔𝒔𝒔𝒔𝒔𝒔𝒔𝒔𝒔 (𝑬𝑬)
Ke=
𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴 𝒗𝒗𝒗𝒗𝒗𝒗𝒗𝒗𝒗𝒗 𝒐𝒐𝒐𝒐 𝒔𝒔𝒔𝒔𝒔𝒔𝒔𝒔𝒔𝒔 (𝑺𝑺)
3. Overall capitalization rate (ko):
𝑵𝑵𝑵𝑵𝑵𝑵 𝒐𝒐𝒐𝒐𝒐𝒐𝒐𝒐𝒐𝒐𝒐𝒐𝒐𝒐𝒐𝒐𝒐𝒐 𝒆𝒆𝒆𝒆𝒆𝒆𝒆𝒆𝒆𝒆𝒆𝒆𝒆𝒆𝒆𝒆 (𝑶𝑶)
Ko=
𝑻𝑻𝑻𝑻𝑻𝑻𝑻𝑻𝑻𝑻 𝒎𝒎𝒎𝒎𝒎𝒎𝒎𝒎𝒎𝒎𝒎𝒎 𝒗𝒗𝒗𝒗𝒗𝒗𝒗𝒗𝒗𝒗 𝒐𝒐𝒐𝒐 𝒇𝒇𝒇𝒇𝒇𝒇𝒇𝒇 (𝑽𝑽)
where, V= B+S
or,
𝑩𝑩 𝑺𝑺
Ko= 𝒌𝒌𝒌𝒌 + 𝒌𝒌𝒌𝒌
𝑩𝑩+𝑺𝑺 𝑩𝑩+𝑺𝑺
Total Value of the firm
O Net operating earnings
-F Interest
-----------------------------------------------
=E Earn.avail.to com. stockholders
*ke Equity capitalization rate
--------------------------------------------------------
S Market value of stock
+B Market value of debt
----------------------------------------------------------
=V Total value of firm
Arbitrage steps:
1. Sell the stock in Company B for xxx which is 1% of all share.
2. Borrow 1% of corporate debt of Company B.
3. Buy 1% of the shares of Company A for yyy.
Calculate Return
Return in Company B: ke% of xxx =
Return in Company A: ke% of yyy =
Less interest: i% of loan =
Net return=
Calculate Cash outlay
Outlay in Company B=
Outlay in Company A=
Less Personal debt=
Net outlay=
When personal taxes are absent,
PV of the tax shield = TcB
When personal taxes are present,
(𝟏𝟏−𝒕𝒕𝒕𝒕)(𝟏𝟏−𝒕𝒕𝒕𝒕𝒕𝒕)
PV of tax shield= [1- ]*B
𝟏𝟏−𝒕𝒕𝒕𝒕𝒕𝒕
𝑬𝑬𝑬𝑬𝑬𝑬𝑬𝑬.𝒂𝒂𝒂𝒂𝒂𝒂𝒂𝒂𝒂𝒂.𝒕𝒕𝒕𝒕 𝒄𝒄𝒄𝒄𝒄𝒄.𝒔𝒔𝒔𝒔𝒔𝒔𝒔𝒔𝒔𝒔𝒔𝒔𝒔𝒔𝒔𝒔𝒔𝒔𝒔𝒔𝒔𝒔𝒔𝒔
Value of the unlevered firm (Vu)=
𝒓𝒓𝒓𝒓𝒓𝒓.𝒓𝒓𝒓𝒓𝒓𝒓𝒓𝒓 𝒐𝒐𝒐𝒐 𝒓𝒓𝒓𝒓𝒓𝒓𝒓𝒓𝒓𝒓𝒓𝒓
Value of the levered firm (Vu)= VL = Vu + Tc.B
Chapter 9: Dividend
𝑫𝑫𝑫𝑫 + 𝑷𝑷𝑷𝑷
P0=
𝟏𝟏 + 𝒌𝒌𝒌𝒌
mP1= I - (X - nD1)
OR,
I = mP1+ (X - nD1)
Where,
Po=MPS at the beginning of a period
D1=dividend paid at the end of the period
P1=market price at the end of the period
I= Investment
X= Earnings
n= no of share outstanding
m=no of new share at t1
BF Hudson
A. Wilson’s Inc. A. Leasing arrangement
B. Mountain View Gas & Electric B. Preferred stock (Nonconvertible)
C. Pride O’ the Hills Canning Company C. Factoring
D. Common stock (Right offering)
D. Piper Pickle Company
E. Debt with warrants
E. Lucky Lode Mining Company
F. Friends and relatives
F. Hogtown Saloon and Dance Hall
G. Convertible Debentures
G. Starcruiser Aircraft Corporation
H. Common stock (Non-rights)
H. Zephyr Yachts I. Long-Term Bonds
I. Bushnell Pen Corporation
