IFM10 Ch16 Solutions Manual文档格式.docx

1、 Part IIANSWERS TO BEGINNING-OF-CHAPTER QUESTIONS16-1 Arbitrage is generally thought of as the process of buying an item in one market and simultaneously selling it at a higher price in another market and thus earning a riskless profit. MM broadened this concept. They show, under a set of assumption

2、s, that personal debt can be used to cause the risk of two different stocks to be the same but the returns on the stocks can be different. Then, one could buy the cheaper stock and simultaneously sell the more expensive one and end up earning a riskless profit. Using this arbitrage concept, they dem

3、onstrated that if an unlevered firm had a higher value than a leveraged firm, then investors could use “homemade” leverage to earn a riskless profit by selling the leveraged firms stock and borrowing to buy stock in the unlevered firms stock. So, investors would get to the same debt position and hav

4、e the same risk, but earn a higher profit. The MM conclusions were based on a number of assumptions, and in the real world, those assumptions are not correct. Investors cannot necessarily borrow at the same rate as corporations, interest rates increase with the amount borrowed, bankruptcy costs do e

5、xist, and so on. Moreover, in bad times corporations are more likely to use cash flows to service their own debt than they are to pay dividends to enable stockholders to service “homemade” leverage debts, which could result in additional risk to the personally leveraged investor. It should be noted

6、that many of the arguments against the MM assumptions are valid if one thinks about individual investors like college professors but less valid if the “investor” is an institutional investor like a pension fund that has ready access to capital and may not have to pay taxes. Then, taxes and brokerage

7、 costs may really be immaterial, borrowing costs may be the same for the investor and the company, the investor and the firm may have the same information, and the investor may have enough clout to force the company to provide cash to service the investors debt. As a result, arbitrage undoubtedly wo

8、rks better for certain large investors than for small investors. The use of debt in corporate America increased after MM published their work, and we believe that MMs work contributed to this development.16-2 Miller added personal income taxes to the MM equation. He argued （1） that the personal tax

9、rate was high on interest income and dividends but much lower on capital gains income, and （2） that individuals could use various tax shields, including death, to avoid capital gains taxes, while corporations could retain earnings, use stock buy-back programs, and so on to help stockholders minimize

10、 personal taxes on income from stock. Millers conclusion was that investors could essentially avoid taxes on stock income, hence they had a much lower risk-adjusted required rate of return on stocks than on bonds, and that this advantage largely offset the tax advantage to corporate debt. Here is Mi

11、llers formula for the gain from leverage: Gain from leverage = D Note that if all the tax rates were zero, the gain from leverage would reduce to zero, and we would be back at the original MM position. Miller personally thought that this was the most likely situation. Note also that if Ts = Td, i.e.

12、, the tax rates on stock and debt income are equal, then the gain from leverage is equal to TcD, which is the MM with corporate taxes position. Most subsequent researchers concluded that Miller had a good point, but the personal tax advantage of stock only partially, not completely, offset the advan

13、tage of corporate debt, because Td Ts. For example, suppose that Tc = 35%, Td = 28%, and Ts = 10%, then the term in brackets will be 1 - （1-.35）（1-.10）/（1-.28） = 0.1875 versus .35 under the MM with-taxes model. The gain from leverage with other tax rates is shown in the model output. The Miller Mode

14、l leads us to the conclusion that the “Pure MM” line in the value graphs should have a less steep slope that TD, and that, in turn, leads to the conclusion that the optimal capital structure in the trade-off model should include somewhat less debt.16-3 Under the MM and Miller assumptions, firms do n

15、ot grow and the debt tax shield is discounted at the cost of debt. Under these assumptions the value of the unlevered firm is VL = VU + TD and the levered cost of equity is rsL = rsU + （rsU rd）（1-T）（D/S）. This expression for the levered cost of equity also means that the WACC decreases as the level

16、of debt increases. However, if firms are allowed to grow, then two differences emerge. First, the present value of a growing tax shield is larger than the present value of a constant tax shield, so the contribution to value that the debt tax shield makes is larger. Second, the value of the growing t

17、ax shield doesnt make any sense if the discount rate is the cost of debt, because using such a low discount rate allows the value of the growing tax shield to dominate the value of operations, which makes no economic sense. Rather, the discount rate for the tax shield must be the unlevered cost of e

18、quity, which is larger than the cost of debt. Using a higher discount rate makes the tax shields contribution to value smaller than if the cost of debt had been used to discount it. These two opposite effects lead to the result that the present value of the growing tax shields when discounted at the

19、 unlevered cost of equity is VL = VU + （rdTD/（rsU g）. The levered cost of equity under these assumptions is rsL = rsU + （rsU rd）（D/S）; both the tax rate and the growth rate drop out of the expression and it looks like MMs result, but without taxes. This means that everything else equal, MMs calculat

20、ion of the levered required rate of return is smaller than it would be if growth were accounted for. This also means that the calculation of WACC under MM will be smaller than the calculation of WACC under the extension. The end result is that when growth is correctly included in the model, the bene

21、fits due to the tax shield are actually lower than what MMs model suggests. The model for these questions graphs the WACC based on MM and the WACC based on the extension to MM. 16-4 If corporate debt is actually risky rather than riskless as MM assumed, then managers really have the option to defaul

22、t if the value of the company isnt enough to make it worthwhile to pay the interest or principal on the debt. In the simple case of a levered company with zero coupon debt, the equity in the firm looks a lot like a call option on the value of the entire firm, with a strike price equal to the face va

23、lue of the debt. Viewing equity in this way can lead to some dangerous behavior on the part of firm management. For example, options are worth more when the underlying stock is more riskier. The same is true with the equity in a levered firm. If management takes the money that it borrows and invests

24、 it in riskier projects than originally intended, then it makes the firm riskier, and it makes the option value （the equity value） greater. This would be good news for the shareholdersthe value of their stock increases. And it would be bad news for the bondholders. If management isnt investing in hi

25、gher npv projects, only riskier ones, then the increase in the shareholders position is exactly offset by a decrease in the bondholders position. So the shareholders would be expropriating wealth from the bondholders by using a “bait and switch” strategy. Of course bondholders would want to avoid th

26、is if possible, so they would put restrictions on how the money that they lend can be used, or they might charge a higher interest rate because they know this might happen, or they might refuse to deal with the firm again if it happens. ANSWERS TO END-OF-CHAPTER QUESTIONS16-1 a. MM Proposition I sta

27、tes the relationship between leverage and firm value. Proposition I without taxes is V = EBIT/rsU. Since both EBIT and rsU are constant, firm value is also constant and capital structure is irrelevant. With corporate taxes, Proposition I becomes V = Vu + TD. Thus, firm value increases with leverage

28、and the optimal capital structure is virtually all debt.b. MM Proposition II states the relationship between leverage and the cost of equity. Without taxes, Proposition II is rsL = rsU + （rsU rd）（D/S）. Thus, rs increases in a precise way as leverage increases. In fact, this increase is just sufficie

29、nt to offset the increased use of lower cost debt. When corporate taxes are added, Proposition II becomes rsL = rsU + （rsU rd）（1 T）（D/S）. Here the increase in equity costs is less than the zero-tax case, and the increasing use of lower cost debt causes the firms cost of capital to decrease, and agai

30、n, the optimal capital structure is virtually all debt.c. The Miller model introduces personal taxes. The effect of personal taxes is, essentially, to reduce the advantage of corporate debt financing.d. Financial distress costs are incurred when a leveraged firm facing a decline in earnings is force

31、d to take actions to avoid bankruptcy. These costs may be the result of delays in the liquidation of assets, legal fees, the effects on product quality from cutting costs, and evasive actions by suppliers and customers.e. Agency costs arise from lost efficiency and the expense of monitoring manageme

32、nt to ensure that debtholders rights are protected.f. The addition of financial distress and agency costs to either the MM tax model or the Miller model results in a trade-off model of capital structure. In this model, the optimal capital structure can be visualized as a trade-off between the benefit of debt （the interest tax shelter） and the costs of debt （financial distress and agency costs）.g. The value of the debt tax shield is the present value of the tax savings from the interest payments. In the MM model with tax