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Cheat Sheet

1) The document outlines formulas for calculating weighted average cost of capital (WACC), the effects of corporate taxes on WACC, and capital structure considerations. 2) Capital structure impacts WACC and shareholder return. Leverage increases risk but also returns if the tax benefit from debt financing exceeds the higher cost of debt. 3) The tax advantage of debt financing diminishes as a firm takes on more debt, as the marginal tax benefit declines. Firms should borrow until the marginal benefit of interest tax shields equals the marginal cost of financial distress.

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Dimana Dollo
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114 views

Cheat Sheet

1) The document outlines formulas for calculating weighted average cost of capital (WACC), the effects of corporate taxes on WACC, and capital structure considerations. 2) Capital structure impacts WACC and shareholder return. Leverage increases risk but also returns if the tax benefit from debt financing exceeds the higher cost of debt. 3) The tax advantage of debt financing diminishes as a firm takes on more debt, as the marginal tax benefit declines. Firms should borrow until the marginal benefit of interest tax shields equals the marginal cost of financial distress.

Uploaded by

Dimana Dollo
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
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1.#GENERAL#FORMULAS# 3 #step:!Lend/Deposit!
!"!!"#$%& !"#$%$&#!!"#$%&'!!"#"$"%
!"#$%& − !" − !""#!!"#$% = ,!!!! > 1, !"#$%&'(!!"#$%! != !
!"!!"#$%& !!
! #
!"#$%&'#!!"#$% = !
!"#$% #
!
!"#!!"#$%& = !"!!"#$%& 3.#EFFECT#OF#CORPORATE#TAXES#
!"# = , !"#$: !"!# = !"!!!!ℎ!"!! = ø! #
!""#!!"#$%!!"!!"#$%& !!"# = ! !"#$% + !" !"# = !"#$%& + !"#$
! !
! !(!"#) !"× 1 − !
!! = = ! = !
!! !!!"#$% 1 + !"#$% − !"#!!"##! !
!
!!!

!!"!!"# = !!"#!!"# − !"#. +!"#!"#$%&' ! • !" !"# !!tax!saving!generated!by!paying!interest!to!creditors!


!
!

!"#ℎ!!"#$ !"#$× 1 − !
!"# = − !! ! !!"#$%$&$' = !
1 + !!!"#$% !!!"#$% − !
!
!"#!"#!"#$ !"(!"#) ! !
!"#!!"#$%!!"#$% = !"#!!ℎ!"#!!"#$% + + ! !"#$% − !"#!!"## = !!!"# × + !! × 1 − !! !
#!!ℎ!"#$ #!!ℎ!"#$ !!"# !!"#
!
!"#$%!"#$%& !
!= A) PREDETERMINED,#TRANSITORY#DEBT#
!"#!!ℎ!"#$ + # ! !
!"#$%&!!"#$%& = !×# 1
1−
!
!"!""#$%& !, ! = 1+! !
!! = #!!ℎ!"#$×!!!!"# ! !
!
!
!
#!!"#!!ℎ!"#$×!!"!!"# + #!"#!!ℎ!"#$×!!"#!!!!"#$ B) ABSOLUTE#VALUE#
!"#!!"#$% = !
#!!!" + !"#!!ℎ!"#$ !
!
!!!"# = !!!"#$% + ! − !! 1 − !! !
!
! !!"#$%
!""#$#%&'(!!"#$ • AfterMtax!WACC!and!r!!"#$% !change!over!time!
#!!"#$%!!!"#$%&'() = !
!"#!!ℎ!"#!!"#$% !! ×!! ×!!
!"#ℎ! !" !"#$%$&#!!"#!!"#$%&! = = !! ×!! !
!
!"#$%"&!!"#$%&!!"#$%! !""#$ = #!ℎ!"#$× ×! ! !!
!ℎ!"# !!!"# • Higher!!"(!"#):!cost!of!tax!savings!discounted!at!!! !
!

!!"#$% = !!!!"# − !!!!"#!!"#$%!!"#!!"!!""#$%&'!!"#$ ! !


# C) RELATIVE#VALUE#
! !! ×!!
ARBRITRAGE#(rights):# !!!"# = !!!"#$% + ! − !! 1 − !
! !!"#$% 1 + !!
If!we!buy:!
• AfterMtax!WACC!and!r!!"#$% !remain!constant!
!"#ℎ!!"#$%: !"#×#!!"#!!ℎ!"#$ − !"#$%!!"#!!ℎ!"#!
!"#$%"&!!"#$%:!!!!!"#!!"#$%!!"#!!"!!""#$%&'!!"#$ ×#!"# + !"#!!ℎ!"#! 1 + !!!"#$% !! !! !!
!" !"#$%$&#!!"#!!"#$%&! = × !
! 1 + !! !!!"#$% − !
If!we!sell:! • Lower!!"(!"#):!cost!of!tax!savings!discounted!at!!!!"#$% !
!"#ℎ!!"#$%: !"#×#!!"#!!ℎ!"#$ + !"#$%!"#!!" ×#!!"#ℎ!"! !"× 1 − !
!"#
!"#$%"&!!"#$%:!!!!!"#!!"#$%!!"#!!"!!""#$%&'!!"#$ ×#!"#!!ℎ!"#$! ! = !
!"## − !
! !
! D) CONTINUOUSLY#REDBALANCED#
!
2.#CAPITAL#STRUCTURE#IN#A#PCM# !!!"# = !!!"#$% + ! − !! !
! ! ! !!"#$%
!"## = !! × + !! × ! !"#!!"!!"#$%&'()*"#!!"!!"#$ ! !! ×!! ×!ø
! ! !" !"# = !
!!!"#$% − !
• Levered!equity!has!a!greater!return!(risk!premium)!
! !
!"#$ • Tax!advantage!diminishes!as!the!firm!keeps!on!borrowing!
!"#$%!!"!!"#$%&' = !!(!ℎ!"!!!"#!!"!!"#$%)!
!!!"#$% = !"## • Companies!should!borrow!until!marginal#effect#ITS#=#0!
! #
!!!"# = !!!"#$% + ! − !! !
! !!"#$%
• !!!"#$% !return!from!exposure!to!business!risk! #
• !!!"#$% − !! !!extra!return!from!exposure!to!financial!risk!(leverage)! 4.#EFFECT#OF#PERSONAL#TAXES#
!!!"#$% = !!"#$%&## ×!!"#$%&## + !!"#$ ×!!"#$ ! !!_! − !!_!
!"##"$!!"#$%: 1 − !!! = 1 − !! 1 − !!! !! ∗ = !
! ! − !!_!
! Ø# !!"#"$"% = !!"#$% + !" !"#
Companies!that!sit!in!a!pile!of!cash!carry!a! + !" !"#$%&'(!!"#$%!!"!!"#$%&'$(!!!"#$%&!!"#$%&
! lower!equity!risk!!
# − !" !"#$%&'(!!"#$%!!"!!"#$%$&#!!"#$%& !
# !

HOME#LEVERAGING# ABSOLUTE#VALUE#
Levered!undervalued!arbitrage!gain!by!buying!unlevered!firm,!leveraging!it!and! ! − !! ! − !! !
!!"#"$"% = !!"#$%$&$' + ! − ×! !
selling!the!levered!firm.! ! − !! !
st
1 # step:! Similar! stakes.! Having! !%! of! the! levered! firm,! calculate! the! CFs! due! to! Relative#tax#advantage#of#debt#over#equity#
Earnings!and!Interest!today!and!one!year!from!now.!y%!of!unlevered?! >!0,!tax!advantageous!
!%(!"#$%$&'!!"!1!!"#$, !"#"$"%!!"#$) =!0,!indifferent!
!% = ! <!0,!tax!disadvantageous!(equity!is!more!advantageous)!
!"#$%$&'!!"!!ℎ!!!"#$%$&$' #
nd
2 #step:!Buy!unlevered! Net#benefit#of#Debt#
!%×!"#$%&!!"#$%!!"!!"#$%&, !"#$%$&$'!!"#$! !! − !!_!
# !
rd
1 − !!_!
3 #step:!Borrow/Loan!
!"#$%$&#!!"#$%&'!!"#"$"% #
!= !
!! #
# 5.#EFFECT#OF#COSTS#OF#FINANCIAL#DISTRESS#
HOME#DELEVERAGING# #

!!"#"$"% = !!"#$% + !" !"# − !" !"#$#!!"!!"#$#%"$&!!"#$%&## !


Unlevered! overvalued!buying! levered! firm,! deleveraging! it! and! selling! the!
• Financial!distress:!company!has!difficulty!to!pay!its!creditors!(high!likelihood!of!default)!
unlevered!firm.! !
st
1 #step:!Similar!stakes.!Having!x%!of!the!unlevered!firm,!calculate!the!CFs!due!to! !"#$#!!"!!"#$#%"$&!!"#$%&## = !!"#$% − !!"#"$"% !
!
Earnings!today!and!one!year!from!now.!y%!of!levered?!
!%(!"#$%$&'!!"!1!!"#$, !"#$%$&$'!!"#$) !"#$%&!!"#$%!!"#$%&
!% = ! !"# + !"#$%!!""#$" !" ×!!""#$" + !"# − !"" − !"#$!!"#$%!!"#$
!"#$%$&'!!"!!ℎ!!!"#"$"% = !
nd
2 #step:!Buy!levered! 1 + !!"#$%&
!%×!"#$%&!!"#$%!!"!!"#$%&, !"#"$"%!!"#$! !
# #
VALUE#OF#OLD#AND#NEW#DEBT#
!"
!"#/!"#:! ×!"#$!
!"#$%!!"#$
!
FV#PARIPASSU#DEBT##
MV!debt!is!X;!owe!in!maturity!X+Y;!dilution!wealth!old)!
!
× !"(!""#$"!!"#"$%&"! − !"#$%& = !! !
! + !"#!!"#$
!
• If!creditors!capture!more!than!NPV,!shareholders!worseMoff!
• ! !"#$#!!"!!"#$#%"$&!!"#$%&## < !"#$!!"#$%&'(!eq.holders!worseMoff!
• !"#$!!"#$!!"#!!"#ℎ!!"#$%&'"(; !"#$%&'%"; !ℎ!"!!ℎ!"#$!!"#$!!"#$!!"##$#!
• Adverse!selection!costs!vs.!agency!costs!of!equity!(debt!mitigates)!
• Peck.!order:!1.internal!equity,!2.financial!slack,!3.debt,!4.pass!on!project!
• Optimal!leverage:!mature,!profitable,!tangible/liquid!assets,!stable!profits!
!
UNDERVALUED#FIRM#
!"#$%&
!"#$%&%'($#!!"!!% ∶ !!!!!"#$!!"!!"#$#%&!!"#$%& = !
1 − !%
!
!
6.#FIRM#VALUATION#
#

!"#!!"#$%$&#!!"#!$%! 1
= !%,!!!!"#$%&!!"#$!!"#$%$&#! !!"#$%!
!"#$%& !
!
#

!"#$%&%'($!!"#$%! !" = !"#$%&!" + !"#$!" − !"#$%%!!"#ℎ!


!
!"#$% = !"#$%!!""#!!"#$% − !"#$#%&!!" + !"#$"%&'(&)*!
!
30
!"#$%%!!"#$!!! = !""#$" − ×!"#$%
365
= !"#!!"#ℎ! + !"#$%%!!"#ℎ! × 1 + ! − !"#!!"#ℎ!!! !
!
!"!!"#$ = !"#$ 1 − ! + !"#$"%&'(&)* − ∆!"# − !"#$%!
!
!"!!"#$%& = !"!!"#$ + !"#!!"##"$%&' − !"#$%$&#(1 − !! )!
!
!"#$ = !"#$%& − !"#$"%&'(&)*!
#
!!!"#$% = !! + !! × !! − !! !

×!! !
!"#$%&!!"#$% !"#!!"#$!!"#$%
• !!!"#$% = ×!!!"# +
!"#$%&%'($!!"#$% !"#$%&%'($!!"#$%

!"#$%#&'$%"#!!"#!$%$&'!!!"#$% = !"#$%#&'$%"#!!"#$%&!!"#$% + !"#$!


!
!
MULTIPLES#APPROACH#(FOR!THE!COMPANY’S!EQUITY!VALUE)!
!
: !"#$%&#'!"#$%&'( ×!"#!!"#$%&!
!
!
!"
: !"#$%&#'!"#$%&'( ×!"#$% − !!
!"#$%
!
!"
: !"#$%&#'!"#$%&'( ×!"#$%& − !!
!"#$%&
!
!
DISCOUNTED#CASH#FLOW#APPROACH#
!"!!!!
!"#$%#&'$%"#!!"#!$%$&'!!!"#$% = !(!"#$!!"#ℎ!!"#$%&'"!!"#$)#
!"## − !
!"!!!! = 1 + ! ×!"#$%$&$'!!"#!!"#$%&! − !×!"#!!"#$%&'!!"#$%"&! − !×
!"#$%!!""#$"! !!!!!USE!WHEN!GROWTH!RATE!CHANGES!BETWEN!YEAR!t!AND!YEAR!t+1!
!
When!debt#is#constant#in#relative#value!during!the!!#years:!
!"!!
!! = !
!"## − !
!
!
ADJUSTED#VALUE#APPROACH#
!"#$%&%'($!!"#$%!!!
!"!! !"!! !"!!
= + ! + !
1 + !!!"#$% 1+! 1+! !!"#$% !!"#$%
!"!! !"!!
+ ! + !
1 + !!!"#$% 1 + !!!"#$%
!"#$%&%'($!!"#$%#&'$%"#!!"#$% !"#$%$&#!!"#!!ℎ!"#$!
+ ! +
1 + !!!"#$% 1 + !!
!"#! !"#! !"#! !"#!
+ + + +
1 + !! ! 1 + !! ! 1 + !! ! 1 + !! !
! !
!"!! !"! !"#
= ! + ! + !
1 + !!!"#$% 1 + !!!"#$% 1 + !! !
!!! !!!
!
!

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