AN INTRODUCTION

TO DEBT POLICY
AND VALUE
6.53
Why does the value of assets change?

Because there is a change in WACC (weighted-average

cost of capital)due to leverage source of funding which is
the ratio of a company's loan capital (debt) to the value of
its common stock (equity)

Where, specifically, do those changes occur?

Changes occur on a debt section which makes WACC
changes depend on the percentage of Equity and Debt
(Leverage)
As the firm levers up, how does the increase in
value get apportioned between the creditors and
the shareholders?

The increase in value will be shared between

shareholders and creditors.
By using the appropriate weight:
Debt holder will receive %(Debt/(Debt + Equity))
and
Shareholders will receive %(Equity/(Debt + Equity))

Or
When the debt increases, from 0 to 2,500 to
5,000
The value apportioned to shareholders increase
more as the leverage goes up:
★ When the firm uses 25% debt, the market

value of equity is $8,350

★ When the firm uses 50% debt, the market

value of equity is $6,700

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dividing the free cash flows of the firm into pure
business flows and cash flows resulting from
financing effects

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4.
Calculate the share price with equation
Share price = Original market value of equity + Value of financing effect/Number of original shares
Cash paid out = total value in problem 3
Total value/share = cash paid out/ number of original share

Higher Leverage will be generating higher Value per Share

IS LEVERAGE GOOD FOR SHAREHOLDERS? WHY?

Yes, as from the calculations, debt increase the total value per share which will increase value for shareholders,
reduce firm's cost of capital, increase the value of asset, and provide benefit from tax deductible

IS LEVERING / UNLEVERING THE FIRM SOMETHING THAT SHAREHOLDERS CAN DO FOR THEMSELVES?

No, levering / unlevering the firm will depend on management’s decision, policy and regulation, as well as
Bank/Financial Institution involved

IN WHAT SENSE SHOULD SHAREHOLDERS PAY A PREMIUM FOR SHARES OF LEVERED COMPANIES?

Shareholders should pay premium for shares of levered company because by lowering the weighted cost of
capital, company can increase firm's value resulting a higher rate of return
From a macroeconomic point of view, is society better off if firms use more than zero debt (up to some
prudent limit)?

Yes,
From the firm point of view, debt enable a company not only to maximize their profit but also offering
competitive price, thus the overall economic will be improved The fund acquired from debt will be the source
for future investment resulting more stimulus for economic growth

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Recapitalization, Koppers Company, Inc.

• Beazer PLC & Searson Lehman Hurton

commenced a hostile tender offer to purchase all
the outstanding stock of Koppers Company, Inc.
• Raiders offered $45 a share, raised to $56 and
then finally reaching $61 a share
• Assume that Koppers could borrow a maximum of
$1,738,095,000 at a pretax cost of debt of 10.5%
• Koppers will take on additional debt of
$l,565,686,000 (that is, $1,738,095,000 minus
$172,409,000). Also assume that the proceeds of
the loan would be paid as an extraordinary
dividend to the shareholders

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CAN YOU RANK THE PROJECTS SIMPLY BY INSPECTING THE CASH FLOWS?

We can't rank the projects by only simple inspection of the cash flows because of the time value of money and
cost of capital of companies.

WHAT CRITERIA MIGHT YOU USE TO RANK THE PROJECTS? WHICH QUANTITATIVE RANKING METHODS ARE BETTER?
WHY?
NPV provides us with the present value of currency that either gained or lost by undertaking a project. NPV
considers time value of money, but it doesn't give you the information of how long a project or investment
will generate positive NPV
Payback Period states the duration required to recoup the investment (or to reach the break-even point), but
it does not shows the amount acquired or lost money during the investment.
Profitability Index shows the comparison of present value of future cash flows to the current value of
investment made. The desired Profitability Index is greater than 1.
IRR(Internal Rate of Return) depicts the rate of return of a project over its lifespan. IRR can not be used to
evaluate projects with changing cash flows.
WHAT IS THE RANKING YOU FOUND BY USING QUANTITATIVE METHODS? DOES THIS RANKING DIFFER FROM
THE RANKING OBTAINED BY SIMPLY INSPECTION OF THE CASH FLOWS?

Yes, we use the different method of cost of capital.

Weighted Average Cost of Capital (WACC) is calculated by multiplying the cost of each capital source (debt and
equity) by its relevant weight, and then adding the products together to determine the value

WHAT KINDS OF REAL INVESTMENT PROJECTS HAVE CASH FLOWS SIMILAR TO THOSE IN EXHIBIT 1?

Normally bank have recapitalization. Bank recapitalization is a method to infuse new and fresh capital into banks
to strengthen their balance sheet.
Syndicate 7
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