1、Managerial Economics Chapter 12 1Non-debt Tax ShieldsDe Angelo and Masulis (1980) (DM) extended MM and Miller by including other tax shields besides interest, i.e. non-debt tax shields (NDTS). Existence of NDTS taxable income probability of being able to use all of ITSe.g. of NDTS: depreciation and
2、depletion allowances larger are such allowances less is the need for the ITS less is incentive to use FL DM find that such a balancing KS value of debt exercise option, pay bondholders and claim rest of V for stockholders. VVuFL* FLVL = Vu + TBVL = Vu + TB - PTI - NDTSVL = Vu + TB - PTIPTI = persona
3、l tax impactFig. 12-4Managerial Economics Chapter 12 2If there is a loss in value of the firms assets,. then limited liability stockholders walk away and turn firm over to bondholders. loss in value triggers exercising of option the loss in value is what leads to bankruptcy. - Not the reverse Bankru
4、ptcy Costs (BC)BC represent legal and other direct costs associated with bankruptcy or reorganization- only accountants and lawyers benefit from BCBC represent 0 - 5% of V and are not large enough to offset MM arguments. Risk ShiftingA firm in severe FD - where value of debt exceeds current market v
5、alue - may be more inclined to accept riskier projects. Such high risk projects may have NPV 0 of V will be shared between stock- and bondholders larger is debt smaller is incentive to invest. Underinvestment problem - when a firm fails to pursue all growth opportunities (NPV 0) since they will prim
6、arily benefit bondholders. Managerial Economics Chapter 12 3- where FL is high as is FD, FI will occur + this = RA prod. = NOI = prob. is compounded.- This can incentive to search for those side effects which can likewise compound the prob. Operational and Managerial Inefficiencies Due to FD firm ma
7、y try to compensate via: lay off of personnel; lower product quality; less training for workers; less spent on R+D; decrease of worker safety conditions. . in order to survive, the firm sacrifices some important activities which it normally undertakes. (Pinches, p. 354) - but this may only buy time!
8、FD ks P0 Both direct and indirect costs of FD may 10 - 20% of V firms with greater probability of FD will borrow lessAgency Costs (AC)As FL s, AC associated with equity (ACE) - since ownership is less diluted costs of assuring that management pursues owners interests decreaseAs FL s AC associated wi
9、th debt (ACD)AC can arise between suppliers of capital (principals) and between these and management (agents). (12.6) unlevered firms have AC due to ACEACFL* FLTotal ACFig. 12-6 ACDACEManagerial Economics Chapter 12 4ACD as FL s since fixed claim of bondholders .creates an incentive for stockholders
10、 to engage in riskier projects that transfer wealth from bondholders to stockholders . to prevent such expropriation of their wealth . (Pinches, p. 355) bondholders must demand monitoring devices AC FL ACD FL ACD but ACE V is maximized where total AC is minimized FL* (optimal KS)Now, value of firm b
11、ecomesVL = Vu + PV of TS - PV of FDC - PV of AC (12.10)TS = TB - NDTSFDC = FD costsAC = ACD + ACE VL there may be an optimal KS (FL*)Impact on KI DecisionsFDCs + AC do affect KI decisions KS decisions will affect K budgetingVia signaling - process of conveying information through a firms actions - t
12、he choice of KS can cause a change in V The important point with respect to signaling is: KS becomes more of a dynamic, ongoing, evolving decision . (p. 357) there is not a single optimal level of debt. - Since managers have inside informationVFL* FLVLVuVL = Vu + TBManagerial Economics Chapter 12 5D
13、ebt/ Equity Ratios in PracticeFirms, in reality, do not finance with 100% debt since:1) ITS is not the only tax deduction - NDTS exists too2) Costs of FD are too high3) Existence of AC4) KI + KS decisions are not independent Pecking Order Theory (POT) = Myers theory1) Firms prefer use of IGF (which
14、accounts for 75-80% of firms financing) becausea) they seek to avoid costs of external financing by avoiding reliance on external financial markets. b) poor performing firms will not draw attention to themselves by going to financial markets. 2) Firms prefer to pay dividends so that the OC is forego
15、ne KI- dividends are sticky downward they are d when times are good but not d when times are bad3) . firms want some financial flexibility in terms of a cash reserve. (p. 358)- good times debt (retire debt), stock repurchase and mergers- bad times level of cash selling of ST non-cash assets to cash
16、supply of ST debt prices of ST debt interest rates4) If they need external financing, firms issue debt first - new equity is a last resort (p. 358)POT attempts to pull together what we know from theory and practiceFirms act as if they had a target KSAggregate Debt/ Equity RatiosManagerial Economics
17、Chapter 12 6Comparing ratio of debt to market value of equity (DMVE) to ratio of debt to bookvalue of equity (DBVE)Up to 1972 these ratios were approximately equalAfter 72 DMVE DBVE due to of relative stock prices (fig. 12.8, p. 359)Since, P/E17.9 60 - 729.4 73 - 8215.6 83 - 93 divergence of DMVE fr
18、om DBVE due to P/E in 73 - 82 period: which reflects lower relative stock pricesYet in late 80s and early 90s DMVE has converged to DBVE because of:1) higher stock prices2) during the 1980s US firms issued substantial amounts of net new debt financing (both ST + LT), while they actually retired more
19、 stock than they issued. (p. 360)Factors contributing to net stock retirement:1) mergers financed with debt2) leveraged buyouts of publicly traded companies which were taken private with DBVE of 9 to 13) swaps of debt for outstanding stock(1) - (3) d reliance on debt . firms do not always employ the
20、 same amount of FL (p. 360)Industry Debt / Equity RatiosTable 12.2 and 12.3 1) DMVE + DBVE differ substantiallyManagerial Economics Chapter 12 72) there are substantial differences in use of debt among industries and between firms in same industrySetting a Firms Debt/ Equity RatioFirm must determine
21、 its debt capacity - the amount of debt the firm can serviceTools to help determine KS:1) EPS - EBIT Analysis - technique used to examine effect of alternative KSs on EPS compare EPS = EAT/#shares of CS under two alternative debt/ equity ratios- can determine what happens to EPS at various EBIT leve
22、ls as well as determination of EBIT*EBIT* = EBIT level that causes both KSs to produce the same EPS (use 12.11)(12.11)22111*NDTIEBNDTIEB pspsI1, I2 = annual interest expense under alternatives 1 and 2N1, N2 = # of shares under each alternativeDps1, Dps2 = dividends on PS under each alternative2) Cov
23、erage ratios - relate EBIT to interest expense of debt and other cash outflows due to fixed cost financing - to determine ability of firm to repay debt3) Lender standards - to maintain KS in correspondence with external standards, e.g. to maintain firms bond rating excessive debt should be avoided4)
24、 Cash flow analysis - use of scenario analysis to determine CFs under alternative assumptions of future state of economyGuidelines for Setting Debt/ Equity RatiosFocus on (1) taxes, (2) risk and (3) financial slackManagerial Economics Chapter 12 8(1) firm must assure itself of being able to benefit
25、from various tax shields(2) FD is most likely in firms that have high business risk (BR)- high BR exists where most assets are of intangible character (brainpower) these firms must use less debt(3) use of lower FL allows firms to react to NPV 0 opportunities high-growth firms use less debtInternational KS IssuesForeign subsidiaries must use parents overall KS as its guideline. Parent must raise K where it is cheapest and make adjustments at multinational level to achieve its target KS (worldwide KS)
