modigliani_and_miller,_taxes,_trade-off_theory

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1、ModiglianiandMiller,Taxes,Trade-OffTheoryDr.JackFavilukisRoomA358j.favilukis@lse.ac.ukpages.stern.nyu.edu/~jfaviluk/teaching.html1QuickQuestionIhaveaprojectthatpaysme100or200with50%probabilityIneedaninitialinvestmentof80togettheprojectgoingTheappropriatedis

2、countrateis0%andIamriskneutralWhatistheNPV?WhatistheexpectedpayouttomeifIraisetheinitialinvestmentwith100%debt?100%equity?50%mix?2DebtFinancingNPV=-80+.5*100+.5*200=70100%DebtFinancing:Ipromisetorepay80whentheprojectisrealized-Iamleftwith100-80=20inbadstate

3、-Iamleftwith200-80=120ingoodstate-Myexpectedpayoutis.5*20+.5*120=703EquityFinancing-Ipromiseinvestorsashareαofpayout-Theyreceive100αinbadstate-Theyreceive200αingoodstate-Theirtotalexpectedpayoutis.5*100α+.5*200α=150α-Thismustequaltheirinitialinvestment:150α

4、=80α=53.3%4EquityFinancing-Iamleftwith:(1-α)*100=100(1-.533)=46.7inbadstate-Iamleftwith:(1-α)*200=200*1-.533)=93.3ingoodstate-Myexpectedpayoutis.5*46.7+.5*93.3=70-Notewithdiscountingitwouldbe150α/R=805MixFinancing-Imustraise.5*80=40fromcreditors,equityget

5、stherest-Equityreceives100-40=60inbadstate-Equityreceives200-40=160ingoodstate-IpromiseshareαofequitypayouttoequityinvestorsfromwhomImustraise.5*80=40-Theyreceive60αinbadstate-Theyreceive160αingoodstate6MixFinancing-Theirtotalexpectedpayoutis:.5*60α+.5*160α

6、=110α-Thismustequaltheirinitialinvestment:110α=40α=36.4%-Iamleftwith(1-α)*60=38.2inbadstate-Iamleftwith(1-α)*160=101.8ingoodstate-Myexpectedpayoutis.5*38.2+.5*101.8=707M&M1NotethatitdidnotmatterhowIraisedfunds:fromdebt,fromequity,oramixThetotalpayouttomerem

7、ainedthesame!ThisisM&M1:whentherearenotaxesorotherfrictions,financingdoesnotaffectvalueAnalogytoM&M2:whentherearenotaxesorotherfrictions,financingdoesnotaffectWACC-WACCisthediscountrate,sowecantalkaboutvalueorWACCinterchangeably8KeyQuestionsofCorporateFinan

8、ceValuation:Howdowedistinguishbetweengoodprojectsandbadones?Financing:Howshouldwefinancetheinvestmentprojectswewanttoundertake?9ReviewSofarwedidvaluationonly.Welearned:-Discountfreecashflows-Ter