14.

1 Market Value of Equity = Market Value of Assets Market value of Debt & other Liabilities
14.2 MMI In a perfect capital market, the total value of a firm is equal to the market value of the total cash
flows generated by its assets & is not affected by its choice of capital structure.
14.3 Pre-tax WACC

14.4 MMII The cost of capital of levered equity increases with the firms market value debt-equity ratio.
Cost of Capital of Levered Equity

14.7 In perfect capital markets, a firms WACC is independent of its capital structure & is equal to its equity cost
of capital if it is unlevered, which matches the cost of capital of its assets.

14.8

NB 1 A firms net debt is equal to its debt less its holdings of cash & other risk-free securities
15.2

As long as t* > 0
15.3

ITS with permanent debt, constant marginal tax rate no personal taxes
15.5 After-tax WACC

15.7 Effective Tax Advantage of Debt

15.9 Tax disadvantage for excess interest payments t
c
= 0

NB 2 Optimal level of leverage from a tax-saving perspective is the level such that interest equals EBIT
NB 3 Optimal fraction of debt, as a proportional of a firms capital structure, declines with growth rate of firm
16.1 Trade-off Theory

16.2 Debt Overhang, shareholders prefer not to invest in positive NPV projects.
Equity holders only benefit when

16.3 Agency Costs + Trade-off Theory

NB 4 Bankruptcy. Direct firm & creditor: legal, accounting, auctioneers, appraisers, investment bankers. Indirect:
loss of customer, supplier, employees, receivables, fire sale assets, cost to creditors, inefficient liquidation.
NB 5 When securities are fairly priced, original shareholders of a firm pay the PV of costs associated with B & FD
NB 6 Agency Costs: Asset substitution, making riskier -NPV investments, Debt Overhang, Cashing Out for dividend
NB 7 Agency Benefits: Ownership Concentration, Reduced FCF, - managerial entrenchment and + commitment
NB 8 Leverage may be used as credible signal to investors of a firms ability to generate future FCF
NB Managers are more likely to sell equity when they know a firm is overvalued, pecking order hypothesis.
NB

where r
m
is expected market return