Tài chính doanh nghiệp - Lecture 11: Corporate equity, debt and taxes

Purely discretionary Young firms typically pay none NASDAQ dividend yield virtually zero Corporate culture influences dividends. Microsoft Liquidity constraints on dividends

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Lecture 11: Corporate Equity, Debt and TaxesLeverageCorporate Leverage is measured by Debt D divided by equity E.Highly levered firms court bankruptcyUnlevered firms cannot go bankrupt (Microsoft owned $5.9 billion of other firms’ long-term debt and $23.8 billion in cash and short-term investments in 2000.Xerox Corporation Consolidated Balance Sheet 1999 (in millions)Assets:Cash $126Receivables $15940Inventories $2961Buildings & equipment $2456Other $7331Total $28814Xerox Corporation Consolidated Balance Sheet 1999 Cont.LiabilitiesShort-term debt $3957Long-term debt $10994Deferred taxes $2263Preferred stock $669Other $6020Shareholders equity $4911Total $28814Microsoft Balance Sheet 2000 (in $ millions)Assets:Cash & equivalents $4846Short-term investments $18952Property & equipment $1611Equity and debt investments $17726Other $9015Total assets $52150Microsoft Balance Sheet 2000 in $Millions Continued.LiabilitiesIncome taxes $585Accounts payable $1016Unearned revenue $4816Other $4065Stockholders equity $41368Total $52150No debt: no corporate bonds or bank loans!Comparing Market CapsXerox Market Capitalization = 667 million shares  $6.95/share = $4.6 billion 2/11/01 (compare with shareholders equity = $4.9b.)Microsoft Market Capitalization = 5.3 billion shares  $59.13/share = $315.3b. (compare with stockholders equity=$41.4b)Expected Return on AssetsExpected return on assets = rA= weighted cost of capital = expected return on a portfolio consisting of all of a companies liabilities.Value of Firm in Terms of rASuppose Dividends are constant =Div and debt is perpetual, paying Coupon C.D=C/rD and E=Div/rEValue of firm = V=D+E=C/rD+Div/rEValue of firm = V = (C+Div)/rArA=weighted average cost of capital = (D/(D+E))rD+(E/(D+E))rEFirm’s Objective: Maximize Overall Market Value VPresent Value Model: V=(C+Div)/rAStrategies: Increase C+Div, or lower rate of discount rA.Traditional Position (Before Modigliani-Miller)Both rD and rE are not much affected by the ratio, probability of bankruptcy is so low that it is approximately zero.Since rD<rE, so firms should borrow money and buy back shares to lower rA, thereby raising the value V of the firm.Modigliani-Miller In absence of taxes, value of firm is independent of D/E.D/E only affects division of income stream between C and Div, so one who buys all D and all E doesn’t care what D/E is. Hence, V is unaffected by D/E.Adding Taxes to M&MInterest paid is deductible for corporate profits taxes, dividends paid are not.Therefore, raising D/E raises numerator of V: firms can pay out more since their taxes are lower.Conclusion: firms should make D=V?Problem with that: if D/E=, the firm is bankrupt, and debt becomes equity.Bankruptcy Costs Limit D/EIf D/E gets too high, the probability of a bankruptcy gets too high.Bankruptcies disrupt the operations of the firm.Legal costs.Conclusion: Each firm must judge how high it can push D/E against its risks and costs of bankruptcy.Recent Trends in Corporate DebtJust as firms are paying less dividends to reduce taxes, they are also borrowing more.Typical large firm in late 1990s purchased 2% of shares per year, issued 1%, so 1% net repurchase.In first 11 months of 2000, firms issued $146 billion in equity, and $935 billion in corporate bond marketDebt is becoming riskier, more equity-likeOther Motives for Issuing Corporate DebtManagement Incentive Options – Management shares in up side, but does not lose in down sideManagement has an increasing incentive to pursue a high-risk strategy in recent years.

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