This tax savings will increase the value of a firm that uses share repurchases rather than dividends when …
While an increase of a firm’s dividend may signal management’s optimism regarding its future cash flows, it might also signal ….
Share repurchases are a credible signal that the shares are under-priced, because if…
…does not change with leverage but …changes
Return(x) = …
RG always equal RE because …
With partial debt financing, NPV for E = …
Tax value = …
FCF = …
Efficient Markets Hypothesis- Implies that securities will be…, based on their future cash flows, given all information that is available to investors. Weak form efficiency- It is impossible to consistently profit by trading on information in ….Semi-strong form efficiency - It is impossible to consistently profit by trading on any …
New debt issuance - When a firm increases its leverage, if its existing debt holders do not have a senior claim in the event of bankruptcy, a new debt issue can ….the value of existing debt. The loss to the old debt holder is transferred to a gain to the …holders.
asset substitution problem - Debt financing forces the firm to give up a good project and undertakes a bad project. It forms the…., borne by…. Hence debt financing wastes resources and is socially un-optimal in this case.
Debt overhang problem - Equity holders may underinvest – that is, …investments because …and the higher interest rate is borne by …
Disadvantage of incentive:
M&A - Bidding firm is…; targeted firm is...
Free-rider problem in takeovers- Small shareholders will not tender their shares if…. As a result, takeovers that could potentially lead to substantial value improvement may fail.
Asymmetric information - Managers who perceive the firm’s equity is underpriced will have a preference to fund investment using…, rather than equity. Issue of equity signal that…. For outside equity financing, …is better than least cost separating equilibrium. For debt financing, only …is possible. Information asymmetry can cause social inefficiency.(good projects passed up and bad projects taken) Debt financing is less …than equity financing, and hence debt financing is better in mitigating the inefficiency of information asymmetry than equity. Information asymmetry leads to wealth reallocation: …
Moral hazard – outside equity financing, manager always …because he gets higher NPV when shirk, regardless of investors’ belief; outside debt financing, manages will ….(thus the face value of debt); hence debt financing is better to mitigate the market friction of moral hazard, given the cost of effort(requirement: working hard payoff > shirk payoff), sometimes both may mitigate
2 irrelevance- In a frictionless market, ie. in the absence of tax and transaction costs…
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