Capital Structure and Value
9 Pages Posted: 7 Apr 2010
This note presents a series of questions that leads students through the essential logic linking capital structure and firm value. It begins with a nontax benchmark, then proceeds through valuations with tax deductibility based on (1) a discount rate with tax effects built in (discount free cash flow at the WACC), (2) the valuation of specific claims (value equity cash flows and debt cash flows separately), and (3) the valuation of types of cash flow (value assets and interest tax shields separately). The note concludes by linking these concepts to stock price effects around recapitalizations. Financial risk (leverage effects on CAPM betas) is also introduced and illustrated.
Keywords: capital structure, valuation
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