Download A Theory of the Firm's Cost of Capital: How Debt Affects the by Ramesh K. S. Rao PDF

By Ramesh K. S. Rao

The price of capital idea has myriad purposes in enterprise decision-making. the normal technique for deriving expense of capital estimates is predicated at the seminal Modigliani-Miller analyses. This ebook generalizes this framework to incorporate non-debt tax shields (e.g., depreciation), interactions among the borrowing cost and tax shields, and default concerns. It develops a number of new effects and indicates how higher expense of capital and marginal tax price estimates might be generated. The book's unified fee of capital concept is mentioned with finished numerical examples and graphical illustrations. This ebook could be of curiosity to company managers, teachers, funding bankers, governmental businesses, and personal businesses that generate fee of capital estimates for public intake.

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Extra resources for A Theory of the Firm's Cost of Capital: How Debt Affects the Firm's Risk, Value, Tax Rate, and The...

Example text

We later generalize the framework to the s × s (“joint s-nomial”) setting, but use numerical methods to compute the debt coupon rate. 12 The statistical (not risk-neutral) probabilities are poo , pop , ppo , and ˜ i and r˜e are available, the parameters poo , ppp . If historical data on Φ pop , ppo , ppp , Φi,o Φi,p , re,o , and re,p can be estimated using maximum likelihood methods. An alternative estimation strategy is to iterate on poo , pop , ppo , ppp , Φi,o , Φi,p , re,o , and re,p to produce desired ˜ i , VAR r˜e , and COV Φ ˜ i , r˜e .

17 The levered firm returns beta (βD+E ) and Equation (5) together yield the WACC. Knowing the expected cash flows and the cost of capital, the firm’s value is implied by Equation (11). Table 7 contains the relevant expressions for the value of the levered firm. 16 Merton’s (1974) debt supply analysis ignores taxes. Miller’s (1977) debt supply arguments emphasize personal taxes and general equilibrium—tax shield risk is not the focus. 17 To express the cost of debt kD in terms of fundamental parameters, eliminate r using the par yield expressions from Table 5.

Either diagonal, then Po Pp Pe,o Pe,p = Pe,o Pe,p and θi = CORR(Φ This page intentionally left blank December 12, 2006 12:22 spi-b456 A Theory of the Firm’s Cost of Capital 9in x 6in ch04 Chapter IV Model Solution Procedure The firm’s cost of capital and the market value of all claims on the firm’s output are determined in four steps. In this chapter we focus on the procedure by which the model is solved. The numerical examples in a later chapter implement this solution methodology. An interpretation of these results is deferred to the next chapter.

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