An Introduction to Debt Policy and Value

In: Business and Management

Submitted By shirleymin
Words 545
Pages 3
Determine whether shareholders are better off or worse off with more leverage. Using the results of problem 2, we calculated the total value per share when firm borrows money to repurchase shares. From the calculation below, we can see that total market value of equity declined from 10,000 to 6,700, while total value per share rose from $10 to $11.70. Therefore, as the firm borrows and repurchases shares, the total value of equity declined, but the price per share rose. Assume that all the new debt is used to repurchase shares. Share price = (Total market value of equity + Cash paid out)/ Number of original shares Based on this assumption change, we will go through all the calculations one more time and estimate the impact of this change across the board. The table 5.1 contains various cost of debts based on various capital structures. In this table we estimate value of operations, value of debt, value of equity, stock price, net income and earnings per share of the firm for various capital structures. Our objective here is to identify the optimum capital structure for the firm. {draw:frame} Table 5.1 – Cost of Debt for various Capital Structures We used the Hamada equation to estimate the impact of the financial leverage on beta. This calculation is done in the table 5.2. The leveraged beta is utilized to estimate the true weighted average cost of capital (WACC) for various capital structures. Table 5.2 estimated the cost of equity, leveraged beta, weighted average cost of capital, free cash flow and the value of the assets for various capital structures. {draw:frame} Table 5.2 – Value of Assets for various Capital Structures {draw:frame} Table 5.3 – Value of Levered firm for various Capital Structures Table 5.3 presents the value of levered firm, which is equal to value of equity (of the value of levered…...

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