An Introduction to Debt Policy and Value
5 Pages Posted: 21 Oct 2008 Last revised: 10 Nov 2021
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An Introduction to Debt Policy and Value
Abstract
This exercise consists of a set of incomplete worksheets with which students must calculate (1) the effect of hypothetical changes in capital structure on firm value, and (2) the effect of a major recapitalization on the share price of Koppers Company. Illustrating in particular Modigliani and Miller's theory about the relationship between debt and firm value in a taxable world, this exercise lays important conceptual foundations in the area of firm valuation and sketches the three classic approaches to valuing the firm.
Excerpt
UVA-F-0811
Rev. Jan. 4, 2019
An Introduction to Debt Policy and Value
Many factors determine how much debt a firm takes on. Chief among them ought to be the effect of the debt on the value of the firm. Does borrowing create value? If so, for whom? If not, then why do so many executives concern themselves with leverage?
If leverage affects value, then it should cause changes in either the discount rate of the firm (that is, its weighted-average cost of capital) or the cash flows of the firm.
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Keywords: debt policy, financial policy, leverage, liability management, tax issues, Modigliani and Miller, firm valuation, debt tax shields, value additivity
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