Issuing securities
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Transcript of Issuing securities
Issuing securities
And considerable review
Reading 9, 10 (light on CAPM, heavy on SML),
12,13 (esp.13.1-13.4), 14.1, 15, 16, 18 (but not the appendix) 22.1, 22.3.
Review Sessions Review session: E. Chernobai, Weds.,
12-11, NH 1110, 7:00-9:00. Review session: Marshall, Thurs. 12-
12, NH 1006, 2:00-3:30.
Office hours Marshall: Weds. 3:30 - 5:00
Thurs. 3:30 - 4:30 Fri. 11:00 – 12:00
Ge: Sat. 10:30 – 12:00, 1:00 – 5:00 Sun. ditto
Chernobai: Fri. 10:00 – 12:00 Seo: Thurs. 10:00 – 12:00, 1:00 – 2:00,
3:30 – 5:00 Fri. 9:00 – 12:00
Review item What is a channel?
Answer Debt and equity are channels. They carry corporate earnings to investors. The debt channel is exposed to personal
taxes only. The equity channel is exposed to corporate
and personal taxes. Some tax-class clienteles value debt over
equity. Some value equity over debt.
Dividend review Dividend smoothing is a fact. We rarely
see firms changing dividend policy. The fact is hard to understand, because
dividends seem to be the basis of valuing firms.
Inescapable conclusion: Dividend policy is irrelevant to value of firms.
Elements of understanding Separation theorem (no taxes) Channels model (with taxes)
Separation theorem interpreted for dividends (Figure 18.4)
C1
C0
s lo p e = - (1 + r)
L o w -d iv id e n d fir m
H ig h -d iv id e n dfirm
w
F u tu rere tu rno r
d iv id e n d n o
Homemade dividends Investors who want higher dividends
sell some shares to get cash. Those who want lower dividends use
high dividends to buy more shares.
Dividend equilibrium
$ of operatingcash flows
HiDivvalueper $1
LoDivvalueper $1
mq ili riuo iv
EL
mEquilibriuHiD iv
u bD
V*=1/Rh V*=1/RL
...
Dividend smoothing explained Changing dividend policy does not raise
value. It hurts, if anything. Right now, December 2002, a tax decrease
is proposed for dividend income to individuals. The effects are unclear.
A firm that changes dividend policy correctly can potentially increase its value.
After the tax code changes firms raise their value by changing their
dividend policy in the right direction.
Cut in capital gains tax rates
$ of operatingcash flows inthe economy
HiDivvalue
LoDivvalue
Increased valueof old equity
More LoDivfirms
Dilemma for a firm Pay dividends: Shareholders pay extra
taxes. Invest in financial markets: Firm
becomes a mutual fund.
Solution: use the cash to buy stock
Investors who sell are those who want cash.
Stock price is unaffected … in theory. Stock price is little affected, in fact.
The IRS understands the buyback game.
Stock buyback for tax avoidance is illegal.
Therefore...
Excuses, excuses always another reason for a stock
buyback, usually ... our shares are a good
investment or...we disburse cash to prevent
takeover.
Summary Dividend policy is like capital structure. It probably doesn’t matter. If it does, it matters because of taxes,
and even that is temporary. In equilibrium, firms cannot increase
value by changing capital structure or dividend policy
The Costs of Public OfferingsProceeds Direct Costs Underpricing
(in millions)SEOs IPOsIPOs 2 - 9.9913.28%16.96% 16.36%
10 - 19.998.72%11.63% 9.65%20 - 39.996.93%9.70% 12.48%40 - 59.995.87%8.72% 13.65%60 - 79.995.18%8.20% 11.31%80 - 99.994.73%7.91% 8.91%
100 - 199.99 4.22%7.06%7.16%200 - 499.99 3.47%6.53%5.70%500 and up3.15%5.72% 7.53%
What is capital structure? The division of the value of the firms
assets between debt and equity.
Worrisome question When a firm sells debt and rebuys its
equity, the new equity is smaller than before. Doesn’t equity therefore lose?
Answer: Old equity got the gains. That is, shareholders at the time of the
restructuring got the gains.
The MM Propositions I & II (No Taxes)
P1: Value is unaffected by leverage P1: VL = VU
P2: Leverage increases the risk and return to stockholders(formula to follow)
Proposition II of M-M rB is the interest rate rs is the return on levered equity r0 is the return on unlevered equity B is value of debt SL is value of levered equity rs = r0 + (B / SL) (r0 - rB)
MM I with taxes VU = market value of the unlevered firm VL = market value of the levered firm B = market value of bonds TC = corporate tax rate result VL = VU + TC B
Short derivation Each year the tax shield is rBTCB Value of tax shield is rBTCB/rB = TCB
Effect of tax shield Increase of equity risk is partly offset by
the tax shield rS = r0 + (1-TC)(r0 - rB)(B/SL) Leverage raises the required return less
because of the tax shield.
MM II and WACC
Debt-to-equityratio (B/S)
Cost of capital: r(%)
.r0
rS
rB.0.200=
0.100
. rWACC
.0.2351
200370
ChannelsOperatingCashFlows=$1
Tc
Ts
(1-Tc)(1-Ts)1-Tb
Tb
Debtchannel
Equitychannel
Value asequity
Value asdebt
Operating C.F.’s ofthe whole economy
D of Institutions D of rich investors
V* = 1/Rb V* = 1/Rs
asdebt
as equity
Miller: Tax-class clienteles
Value asequity
Value asdebt
Operating C.F.’s ofthe whole economy
tax reform
increaseddebt
...
Exam review question A portfolio consists of the risk-free
asset and a risky asset A. The standard deviation of return on A is
.1. Portfolio weights are .5, .5. What is the standard deviation of the
portfolio?
Var RP( )
),(2
)()( 22
AfAf
AAff
RRCovxx
RVarxRVarx
Var RP( )
),()25(.2
)(25.)(25.
Af
Af
RRCov
RVarRVar
05.P
0025.)01(.25.