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1463 1 4630 46
u S e a n
u S e a n
u S e an 1
my X adem
y X
adem
y X
cade c c
EZ A EZ A EZ A

0 0
an 1463 an 1463
y XuSe y XuSe y Xu
S
em em em
EZ Acad EZ Acad EZ Acad

0 0 0
an 1463 an 1463 an 1463
XuSe XuSe XuSe
cademy cademy cademy
EZ A EZ A EZ A

0 0
an 1463 an 1463
y XuSe y XuSe y Xu
S
em em em
EZ Acad EZ Acad EZ Acad

cade
my XuSe
an 1463
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cademy
XuSe
an 1463
0

EZ A EZ A EZ A

UTSG
0 0
1463 1463
y XuSe
an 2022.10.13 y XuSe
an
y Xu
S
em em em
EZ Acad EZ Acad EZ Acad

0 0 0
an 1463 an 1463 an 1463
XuSe XuSe XuSe
cademy cademy c adem
y
EZ A EZ A A
EZ UTSG 校区
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uS e a n
u S e a n
u S e an 1
my X adem
y X
adem
y X
cade c c
EZ A EZ A EZ A

0 0
an 1463 an 1463
y XuSe y XuSe y Xu
S
em em em
EZ Acad EZ Acad EZ Acad

0 0 0
an 1463 an 1463 an 1463
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cademy cademy cademy
EZ A EZ A EZ A

0 0
an 1463 an 1463
y XuSe y XuSe y Xu
S
em em em
EZ Acad EZ Acad EZ Acad

0 0 0
an 1463 an 1463 an 1463
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cademy cademy cademy
EZ A EZ A EZ A

0 0
an 1463 an 1463
y XuSe y XuSe y Xu
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em em em
EZ Acad EZ Acad EZ Acad

0 0 0
an 1463 an 1463 an 1463
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cademy cademy c adem
y
EZ A EZ A A
EZ UTSG 校区
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uS e a n
u S e a n
u S e an 1
my X adem
y X
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y X
cade

Disclaimer
c c
EZ A EZ A EZ A

0 0
an 1463 an 1463
y XuSe y XuSe y Xu
S
em em em
EZ Acad
This complementary study package is provided by Acad
EZ Easy Education Inc. and its affiliated mentors.
EZ Acad
This study package seeks to support your study process and should be used as a complement,
NOT substitute to course material, lecture notes, problem sets, past tests and other available
resources.
0 0 0
an 1463 an 1463 an 1463
We XuSe XuSe XuSe
emyacknowledge that this package contains
cad demsome materials provided by professorsdand
y
ca emy staff of ca
EZ A EZ A EZ A
the University of Toronto, and the sources of these materials are cited in details wherever they
appear.

This package is distributed for free to students participating in Easy Educationʼs review seminars,
4630 4630
and are not for sale uor an 1 commercial uses whatsoever. WeuS
Seother
1
kindly
ean ask you to refrain from S
y X y X y Xu
copying or
A adem in part or in whole any information
selling
c A c adem
provided in this package. Acad
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EZ EZ EZ

Thank you for choosing Easy Education. We sincerely wish you the best of luck in all of your
exams.
0 0 0
an 1463 an 1463 an 1463
XuSe XuSe XuSe
cademy cad emy c adem
y
EZ A EZ A A
EZEasy Education Inc.

0 0
an 1463 an 1463
y XuSe y XuSe y Xu
S
em em em
EZ Acad EZ Acad EZ Acad

0 0 0
an 1463 an 1463 an 1463
XuSe XuSe XuSe
cademy cad emy c adem
y
EZ A EZ A A
EZ UTSG 校区
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u S e a n
u S e a n
u S e an 1
my X adem
y X
adem
y X
cade c c
EZ A EZ A EZ A

CAPITAL STRUCTURE – INTRO OF EQUITY & DEBT

Long Term Debt Securities or borrowing:

630 630
- A debenture (aXloanS e a n 14
contract) is an unsecured corporate debt S e a n 14 S
y u y Xu y Xu
adem adem Acad
em

I
- E A c
AZbond is secured by a mortgage on the corporate E A c
property
Z or a lien on assets. EZ
-
In o
A note is an unsecured debt with shorter maturity than a debenture, perhaps under seven years.
Key Characteristics:
- Loan Contract/Indenture: 契约: The device used by creditors to protect their rights .
0 me 0 0
- Interestn 1463
payments is fully tax-deductible stock n 1463 n 1463
XuS e a
XuS e prospectus
a
XuS e a
c a d emy c a d emy c a d emy
EZ A - Unpaid interest on debt is a liability
EZofAthe firm EZ A
- Seniority indicates preference in position over other lenders. Some debt is subordinated(次级债务).
w

Common shareholders:
463 0 630
-
S n 1the
“Own” the firm andeaare residual claimants
S e a n 14 S
y Xu y Xu y Xu
- adem have cash flow rights (to declared dividends)
Shareholders
A c A c adem Acad
em
EZ EZ EZ

w wt
and voting rights and pre-emptive rights (first chance to
purchase newly issued shares to protect proportion owned)
- If no shares are issued or repurchased, then:
630 year end
Equitynat14current 1463
0
1463
0
e a e a n an
XuS XuS XuSe
c a d emy = Equity end of last year + net income –c a d emy
Dividends cademy
EZ A w w EZ A w EZ A

Preferred shares:
- Typically, no voting rights; and have a stated liquidation value (par value), typically $25 (“par value”)
- Fixed dividend is expressed 30a coupon “a prefer share issued at $25 to yield
6as 630
4.40%”.
S e a n 14 S e a n 14
y Xuare really debt in disguise 伪装的债务 à Stated u
y Xdividend uS
- Preferred
d eshares
m d e m & stated liquidating value (fixed demy X
ca ca me ummm ca
EZ A EZ A EZ A
claim of residual); no participation in the growth of the company

I
- In Canada, corporate investors have an incentive to hold preferred shares issued by other corporations, since
100% of the dividends they receive are exempt from income taxes. Different than for individual investors, who
pay income6tax0 on dividends. 0 0
a n 14 3 an 1463 an 1463
XuS e XuSe XuSe
cademy cad emy c adem
y
EZ A EZ A A
EZ UTSG 校区
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u S e a n
u S e an 1
my X adem
y X
adem
y X
cade c c
EZ A EZ A EZ A

O o
0 0
an 1463 an 1463
XuSe XuSe y Xu
S
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emy emy em
EZ Acad EZ Acad mu
EZ Acad

0 0 0
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cademy cademy cademy
EZ A EZ A EZ A

0 0
an 1463 an 1463
y XuSe y XuSe y Xu
S
em em em
EZ Acad EZ Acad EZ Acad

0 0 0
an 1463 an 1463 an 1463
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cademy cademy cademy
EZ A EZ A EZ A

0 0
an 1463 an 1463
y XuSe y XuSe y Xu
S
em em em
EZ Acad EZ Acad EZ Acad

0 0 0
an 1463 an 1463 an 1463
XuSe XuSe XuSe
cademy cademy c adem
y
EZ A EZ A A
EZ UTSG 校区
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u S e a n
u S e a n
u S e an 1
my X adem
y X
adem
y X
cade c c
EZ A EZ A EZ A

CAPITAL STRUCTURE – FIND THE LOWEST WACC, HIGHEST FIRM VALUE

Optimal capital structure of debt 0and equity: 630

a n 1463 a n 14
S e " % S e S
Þ Lowest y Xu !"## = %! # + %$ (1 − *) #
WACC: emy
Xu y Xu
A c adem &!'&!()*+ "-./ A c a d Acad
em
ÞZ Highest firm valueI=
E EZ EZ
0122 Goal WACCmin FUmox

Financial leverage affects the equity Beta of a company:

4630
1, . 14%6)3
0
1463
0
CAPM: %
e a!
n= 3 + -!4)5(6 (, 7 − ,3 ) and -!4)5(6 = - e
188!( (1
a n + e a n
XuS XuS " XuS
DTinteresttriskonequityreturntcostofequity
c a d emy c a d emy c a d emy
EZ A EZ A EZ A
debtpriority
fixedcostt
• Equity beta is higher if there is more business risk (operating leverage), and more financial risk debut
an my
(operating/financing leverage) à As D/E ratio increase, 09:;<=> increase

• Higher Equity Beta means 30

6higher required return of the equity holders, and 630 WACC
higher
S e a n 14 me S e a n 14 an S
m y Xu m y Xu y Xu
cade cade em
EZ A EZ A ["-./@.A(!'!8(](D@() EZ Acad
Financial leverage affects EPS and ROE variability: 123 =
# GH 8I*'!8 J/L

• risk
The higher level of debt, the higher interest charges

I
o EPS is more volatile if more debt (higher interest payment), for any given EBIT

a
o
n 1463
0
a
o
Solve for the EBIT level at which EPS is the same for different debt level
n 1463
0
a n 1463
0
XuS e XuS e XuS e
a d emy a d emy a d emy
EZ A
c • Example: an all equity firm changing EZits
c c
A mix of financing by issuing some debt to repurchase
EZ A shares
$8,000 of debt will repurchase 8,000/50 = 160 shares

Current Proposed
Asset $20,000 $20,000
6 30 63 0
Debt S e a n 14 $0 $8,000150 160
shares S e a n 14 S
y Xu emy
Xu y Xu
A c adem
Equity $20,000 $12,000 EZ Acad Acad
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EZ 3 EZ
D/E ratio 0.00 2/3
Interest rate - 8%
Shares outstanding 400 240 400
60
Share 630
14Price $50 $50 1463
0
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0
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25g
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XuS XuS XuSe
cad emy c adem
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However
E EPSIROEchanges 导师：YUMI| EASY EDUA
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u S e a n
u S e an 1
my X adem
y X
adem
y X
cade c c
EZ A All – EquityE(P A
Z = $50;S = 400) Levered (P = $50;S = E Z
240)A
mm mm
Recession Expected Expansion Recession Expected Expansion
EBIT $1000 $2000 $3000 $1000 $2000 $3000
Interest 0 0 0 640 640 640 80008
0 30
Net income 1463 6
$360ean 14 $1360
S ean$1000 $2000 $3000
S
$2360
S
m y Xu y Xu y Xu
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Its
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286
A
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ROA = EBIT/Assets 5%
2.5
10% 2.5 15% 5% 10% JEE 15%
ROE = Net income/equity 5% 10% 550 15% 3% 11.3% 19.7%
2550
If If 9
ROE YET
30 YIEI.gg If
146Financial
Practice Question: leverage and EPS 1463
0
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0
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XuS XuS XuSe
c a d emy c a d emy cad emy
EZ A EZ A EZ A
JCB is considering two capital structures:
• Plan I: All-equity plan with 160,000 shares outstanding
• Plan II: 80,000 shares outstanding, $2.8 million in debt @
8% interest and no taxes.
630 630
a. If EBIT is $350,000,
S e n 14plan has a higher EPS?
which
a S e a n 14 S
em y Xu my X
u
emy Xu
$500,000, which plan has a higher EPS? Z Acade
i
cadis
b. IfZEBIT
A Acad
E E EZ
c. What is the "Break-even EBIT"?

EBIT 448,000 EBI 448,000

Solution: 0 0 0
a n 1463 a n 1463 an 1463
uS e ["-./@.A(!'!8(](D@() XuS
[MNO,OOO@O](D@O) e XuSe
y XPlan
ema. I: 123 = # GH 8I*'!8 J/L = emy = 2.1875 emy
c a d c a d
DQO,OOO we cad
EZ A EZ A EZ A

["-./@.A(!'!8(](D@() [MNO,OOO@R,SOO,OOO∗S%](D@O)
Plan II: 123 = # GH 8I*'!8 J/L
= SO,OOO
= 1.575

["-./@.A(!'!8(](D@() [NOO,OOO@O](D@O)
b. Plan I: 123 = 30 = = 3.125 0
# GH 8I*'!8
a
6
n 14 J/L DQO,OOO
an 1463
XuSe XuSe y Xu
S

3
em y em y W Debt is better em
EZ Acad ["-./@.A(!'!8(](D@() EZ
[NOO,OOO@R,SOO,OOO∗S%](D@O)
Acad EZ Acad
Plan II: 123 = =
# GH 8I*'!8 J/L
= 3.45
SO,OOO n

["-./@O](D@O) ["-./@R,SOO,OOO∗S%](D@O)
c. DQO,OOO
=
0 SO,OOO
à EBIT = 448,000
0 0 0
an 1463 an 1463 an 1463
XuSe XuSe XuSe
cad emy cad emy c adem
y
EZ A EZ A A
EZ UTSG 校区
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1463 1 4630 46
u S e a n
u S e a n
u S e an 1
y X y X y X
A c adem A c adem A c adem
EZ Modigliani & miller Irrelevance Theorem: EZ EZ
Capital structure and the pie theory: ; = < + 3 , Does the B/S choice affect the size of the pie?
M&M perfect Wold Assumptions:
mm
a) Homogeneous expectations; Perpetual cash flow v
b) No default risk soSdebt
c) E c
Perfect
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Xu e a
capital market:
630
Im A c a d
XIII
n is14“risk free”, no change of incurring bankruptcy
emy
Xu S e a 1463
ncosts
0

Acad
emy Xu
S
EZ EZ
a. Complete information (no asymmetric information)
win
b. No transaction costs to buy/sell securities for individuals or for firms
c. No taxes
4630 1463
0
1463
0
S an 1
e e a n e a n
y Xu XuS XuS
c a d
=>emCapital structure is irrelevant: Firm value and
c a d emy are the same regardless of the extent of debt
WACC c a d emy
EZ A EZ A EZ A
• Because individuals can borrow/lend to their own to adjust their portfolios to match their preference
• Firm value is the DCF from business activities, and how firm is financed does not affect this
VWXY
o =>?@A = and WACC is invariant to the Debt and Equity Choice
Z[\\
o Shareholders n 630 their own leverage if they want it, by borrowing/lending
can14create 630 on their own account
S e a S e a n 14 S
y X u y X u y Xu
d e m d e m d e m
ca ca ca
A EZ A
HOMEMADE leverage & unleveraged:
EZ A EZ A

ð We can create a levered or unlevered position by adjusting the trading in our own account
w w
ð Homemade leverage suggest that capital structure is irrelevant in degerming shareholder’s wealth (value of
the firm)1à 30
46fundamental insight of MM Proposition I (no taxes)
1463
0
1463
0
e a n e a n an
XuS XuS XuSe
c a d emy c a d emy cademy
EZ A EZ A EZ A
Example continued: HOMEMADE leverage
o Suppose I have $1500 to invest and I can only hold shares of the all equity firm
o Can I reproduce the EPS of the levered firm through borrowing and lending?
mine
630 630
S e a n 14 S e a n 14 S
y XIfumy personal D/E ratio is the same as thateof
Solution:eYES! ytheXulevered firm. y Xu
A c ad m A c ad m Acad
em
EZ $SOOO R EZ EZ
• D/E ratio of the levered firm = =
$DROOO M
R
• Make your personal D/E ratio = 2/3 through borrowing: M ∗ $1500 = $1000 @ interest rate of 8%
www
I
$RNOO
• Invest total $1500 + 1000 = $2500 into the all equity firm and buy $NO
= 50 EℎGHIE
um
0 0 0
an 1463 an 1463 an 1463
XuSe XuSe XuSe
cad emy cad emy c adem
y
EZ A EZ A A
EZ UTSG 校区
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u S e a n
u S e a n
u S e an 1
my X adem
y X
adem
y X
cade c c
EZ A EZ A All – Equity (P = $50;S = 400) EZ A

Recession Expected Expansion

EPS of unlevered firm $2.50 $5.00 $7.50
50 50 450
Earning for 50 shares $125 $250 $375
0 630
a 1463
n on an 1
4
Less: X
interest
S e $1000 (8%) $80 $80 Se$80 S
m y u y X u y Xu
d e
ca Net Profits dem
ca$170 Acad
em
EZ A $45 E Z A $295 EZ
an un
ROE =Net income/equity 3% 11.3% 19.7%
t oo oI
Get the same ROE as if we bought into a levered firm!

630 4630 1463

0
n 14
A XExample HOMEMADE unleveraged uSean 1 n
uSea continued: X XuS e a
cad emy c a d emy c a d emy
EZ A o EZ A
Suppose I have $1500 to invest and I can only hold shares of the levered firm EZ A
o
fume
Can I reproduce the EPS of the unlevered firm through borrowing and lending?

Solution: YES! If I invest in D/E of the levered firm in such a way that the ratio of firm’s D/E in my portfolio
630 firm
is the same as that eofanthe14levered 630
S S e a n 14 S
e m y Xu $SOOO R e m y Xu e m y Xu
• a d ca d ca d
E Z Acratio of the levered firm = $DROOO = M
D/E EZ A EZ A

Umm
^ R
• Share of my funds that I need to invest in the levered firm’s debt is J: = à J = 0.6
D@^ M
o D = 0.4; E = 0.6
Equityportion
oInvest: 0.4 ∗ 1500 = $600 in the levered firm’s debt

I
0 0 0
1463 0.6 ∗ 1500 = $900 in the levered firm’s a
oan Invest: 146to3 purchase $_OO = 18 EℎGHIE
equity
n a n 1463
XuS e XuS e $NO
XuS e
c a d emy c a d emy c a d emy
EZ A EZ A EZ A
Levered (P = $50;S = 400)
Recession Expected Expansion
EPS of levered firm $1.50 $5.67 $9.83
4630 18 18 NS 6 30
Earning for
S e a n18 1shares $27 $102
S
$177
e a n 14 S
u y Xu y Xu
my X
adeLess: dem em
EZ A c interest on $600 (8%)
t $48 EZ t
A c a$48 t $48 EZ Acad
Net Profits $75 $150 $225
ROE =Net income/equity 5% 5500 10% 1800 15% 2Eoo

0 0 0
an 1463 Get the same ROE as the unlevered firm!
a n 1463 a n 1463
XuSe XuS e XuS e
cad emy c a d emy c a d emy
EZ A EZ A EZ A UTSG 校区
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S e a n S e a n S e an 1
Xu y X u y X u
c a d emy c adem c adem
EZ A Practice: EZ A EZ A

Ross, Stephen, et al. Corporate Finance. McGraw Hill, 2022.

16.9 (Home-Made Leverage and WACC) ABC Co. and XYZ Co. are identical firms in all respects except for their
mm mm
capital structure. ABC is all equity financed with $750,000 in stock. XYZ uses both stock and perpetual debt in equal
0 0
1463 1463
Sean$375,000 and the interest rate on its debt isX8uS
proportions; its stock isXuworth ean Both firms expect EBIT to be
percent. S
e m y e m y e m y Xu
a d ca d ca d
$86,000 E Z Acyear, forever. Ignore taxes.
every EZ A EZ A

a) Richard owns $30,000 worth of XYZ’s stock. What rate of return is he expecting?
mm
b) Show how Richard could generate exactly the same cash flows and rate of return by investing in ABC
and using
14homemade
630 leverage. 1463
0
1463
0
an an an
XuSe XuSe XuSe
cademc)
y If Richard owns $30,000 worth of ABC’s estock.
c ad m
y What rate of return is he expecting?
c adem
y
EZ A EZ A EZ A
d) Show how Richard could generate exactly the same cash flows and rate of return by investing in XYZ
mm
and using homemade unleveraged.

a
NIX CEBIT interestL t d NIABC CEBIT interest L t
86000 3250008 0 76 0 86000 0
1463 n 14
63
56000 a n a
399g 86000
Se CF Dividend S e 3440 S
m y Xu y Xu y Xu
Dividend
d e adem Acad
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EZ A
ca
3892 56000 4480 EZ A c
EZ
ROE ROE 34 0 11.467
560 14.93
0
d DIE 0.5 1
b Ms 058.5 1 HML HMUL
n 1463
0
XuS Borrow30,000 1 30,000 8my XuS
e a e a n 1463
0 1 X 0.5 Ex e a n
XuS to NZ
1463
0

emy e 15,000 XYZ 15000 e mylend

EZ A
c a d
EZ A
c a d invest in
EZ A
c a d
Invest 60,000 intoABCshares
CF
NIABC CEBIT interestCI G Dividend 158 0
56000 2240
86000 Interest 15000 89 1200
Dividend Total 3440
99,8
ean
30
1460
86000 6880
ROOM 4480
an 1 4 630
y Xu
Interest
S
300 24g ROEm43481 XuSe 14.939 ROE 3388 11467 y Xu
S
cadem go ca d e y
ca d e m
EZ A EZ A EZ A

ð Homemade leverage suggest that capital structure is irrelevant in determining the value of the firm. You will
mum
not pay more for equity of a firm that has a particular level of leverage because you can create whatever level
630yourself
you want,14for 1463
0
1463
0
e a n an an
XuS XuSe XuSe
cademy cademy c adem
y
EZ A EZ A A
EZ UTSG 校区
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1463 1 4630 46
u S e a n
u S e a n
u S e an 1
y X y X y X
A c adem A c adem A c adem
EZ EZ by leverage: =; = =`
M&M Proposition 1: Firm value is not affected EZ
§ Levered firm:
o Shareholders receive: 1<M* − H- <
o Bondholder receive: H- <
4630 4630
o 1<M* − H-S< e a+n H-1< = 1<M* à PV of this stream of cash flows
S e isn;a1
a S
Xu Xu y Xu
d emy d emy em
c a
EZ o Therefore ;) = ;a
A EZ A c a
EZ Acad

W
M&M Proposition 2: Nb = Nc + (Nc − NW )
b

§ Leverage increases the risk and return to shareholders.

630
14required
Therefore, ROE (HL ) is a linear function of theean 146
30 1463
0
e a n an
XuS XuS XuSe
emy firm’s debt-to-equity ratio emy emy
I DIE
c a d c a d cad
EZ A EZ A EZ A
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 0 EASY EDU | RSM333 W5 知识模块课 | 2022F 30
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导师：YUMI| EASY EDU
moredebtthebetter
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 0 EASY EDU | RSM333 W5 知识模块课 | 2022F 30
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Ross, Stephen, et al. Corporate Finance. McGraw Hill, 2022.

16.25 (WACC Calculations and Cost of Equity at alternative Capital Structures) Williamson Inc. has a debt-to-equity
ratio of 2.5. The firm’s WACC is 10 percent, and its pre-tax cost of debt is 6 percent. Williamson is subject to a
mm 30
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a. What is Williamson’s cost of equity capital?

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b. What is Williamson’s unlevered cost of equity capital?
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c. What would Williamson’s WACC be if the firm’s debt-to-equity ratio were 0.75? 1.5?
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1463 1 4630 46
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导师：YUMI| EASY EDU 14