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

By Ramesh K. S. Rao

ISBN-10: 9812569499

ISBN-13: 9789812569493

The price of capital inspiration has myriad functions in enterprise decision-making. the normal method for deriving fee of capital estimates relies 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 issues. It develops a number of new effects and indicates how larger rate of capital and marginal tax price estimates could be generated. The book's unified fee of capital conception is mentioned with entire numerical examples and graphical illustrations. This ebook might be of curiosity to company managers, lecturers, funding bankers, governmental firms, and personal businesses that generate fee of capital estimates for public intake.

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

Sample text

The “underlying asset” for all claims is ˜ (not the firm’s assets). For each additional dollar of X ˜ net output, X ˜ < A, the depreciation tax shield (NTS ) provides in the range 0 < X ˜ the depreciation tax shield a tax savings of T dollars. When A < X, is fully utilized and the cash flow from it is AT. The depreciation tax shield is equivalent to a long position in a riskless discount bond with principal TA plus a short position in 1 − T put options with ˜ strike price A. The debt tax shield (DTS ) is a bull spread on X, or long T call options with strike price A and short T call options with strike price rD + A.

Our model provides an explanation for this empirical finding. 4). , Majd and Myers, 1985) have noted that, to evaluate the implications of taxes and tax policy changes, one needs a theory that can link these policy changes to the economic (market) values of the various claims. 3rd Reading December 12, 2006 11:15 spi-b456 A Theory of the Firm’s Cost of Capital Discussion of Results 9in x 6in ch05 3rd Reading 43 priced debt, the firm cannot fully eliminate its tax obligation by issuing additional debt.

We assume markets price all assets (including corporate claims) according to Equation (5), with equality. , tax shields, the tax claim) is permissible in the linear factor framework, and the assumptions regarding the return generating process apply only to the traded assets (Grinblatt and Titman, 1983, 1985). The returns beta (or priced risk) of asset i is: ˜ i , r˜e (VAR(˜ re ))−1 , βi = COV R (6) and the cash flow beta of asset i is: ˜ i , r˜e · (VAR(˜ re ))−1 = βi · Vi , βi = COV Φ (7) where Vi is the risk-adjusted present value of i: Vi = ˜i E Φ ˜i 1+E R = ˜ i − βi · (E(˜ E Φ re ) − rz ) .

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A Theory of the Firm's Cost of Capital: How Debt Affects the Firm's Risk, Value, Tax Rate, and The... by Ramesh K. S. Rao


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