I cannot thank you enough. It took me 3days to read a stupid book over and over again until I found this video. I finally passed ny exam after failing 3times. Great job !!!!
wow this video is really helpful I highly recommend it. my lecturer explained this for 2 hour lecture I still haven't gotten a clue, but 10min of this video really helped me a lot better than the lecture
I had a comment about why the cost of equity rises with no bankruptcy costs. I probably wasn't clear, but in this case, their is a possibility of bankruptcy, there just aren't any costs if it happens. Here, there will be a costless transfer of assets from equity to bondholders. In Part 3, I discuss what happens when there is a cost to bankruptcy, i.e. lawyer fees.
Im sorry but is it not obvious that the wacc remains constant under different capital structures if you just assume they are equal when calculating the return on equity?? if you base those first to calculations on the assumption that wacc remains constant, it is obvious that the wacc is gonna come out the same when you calculate it based on those previous calculations which ASSUME the wacc stay constant
kleinesap I guess you could argue that there is some handwaving going on here. RA (WACC) is equal to a weighted average of the returns of debt and equity and then they use this equation to solve for RE, so you're right WACC has to remain the same even when D/E changes. Maybe it's better to think of the pie model. There are 2 ways that the value of the firm can change, 1) a change in cash flow or 2) a change in the WACC. Neither happens by changing the capital structure.
+kleinesap The MM propositions are not about taking Ko constant, it is about explaining why Ko is constant and proving it that capital structure is irrelevant by explaining it through the concept of Arbitrage. Hope u got some clarity.
+Ronald Moy Would you be kind enough to clarify why the WACC stays constant despite a change in capital structure? because your calculation of your new RE is based on the same WACC and therefore you are bound to get back the same WACC value when you plug back the new RE into the equation, which is kind of a chicken-and-egg scenario. Is there a reason why you can make the assumption that WACC stays constant? I can understand why cash flows stay constant but not WACC since it contains both cost of debt and equity. Thanks so much!
I'm a bit confused and would really appreciate help on this quesion I don't get this concept. An unlevered firm is only financed by equity and has no debt The wacc is a weighted average of the companys debt and equity financing and the cost to debt holders/ investors Doesn't the WACC include debt? So why did you use the WACC as the Ra in your example? Isn't the Ra the unlevered Re?
Ra is just the notation I used for WACC. I used the example presented in Essentials of Corporate Finance, by Ross, Westerfield and Jordan to explain the concept. Ra would be the unlevered Re if D=0.
Ronald Moy Thank you very much Sir. If you don't mind I have but one more question that is really confusing me. Ra is the firms business risk so then it follows that the wacc in this case is the business risk. Intuitively that does not make much sense to me as I would think the WACC would pertain to financial risk. I was hope you may help clarify that for me a bit more. Thanks again for your time
In this case, the firm doesn't have anymore before tax cash flow, but what about after tax cash flow? When interest payments are tax deductible, the firm's after tax cash flow increases with the use of debt because the firm pays less taxes when it uses debt instead of equity. Because there are no taxes, there is no tax advantage to using debt. If you use debt to finance the firm you make interest payments. If you use stock, you have to pay stockholders a dividend and the share price will rise less than if the firm didn't pay a dividend. Shareholders don't really care in this case, because they can create their own leverage by borrowing to buy shares if the firm uses all equity to finance the firm. If the firm uses debt and a shareholder doesn't like the use of leverage, he can buy some of the company's bonds to offset this effect.
I cannot thank you enough. It took me 3days to read a stupid book over and over again until I found this video. I finally passed ny exam after failing 3times. Great job !!!!
Me too
wow this video is really helpful I highly recommend it. my lecturer explained this for 2 hour lecture I still haven't gotten a clue, but 10min of this video really helped me a lot better than the lecture
I had a comment about why the cost of equity rises with no bankruptcy costs. I probably wasn't clear, but in this case, their is a possibility of bankruptcy, there just aren't any costs if it happens. Here, there will be a costless transfer of assets from equity to bondholders. In Part 3, I discuss what happens when there is a cost to bankruptcy, i.e. lawyer fees.
Very good job. We need more teachers like you teaching financial theory...
终于看懂了MM定理，谢谢
Im sorry but is it not obvious that the wacc remains constant under different capital structures if you just assume they are equal when calculating the return on equity?? if you base those first to calculations on the assumption that wacc remains constant, it is obvious that the wacc is gonna come out the same when you calculate it based on those previous calculations which ASSUME the wacc stay constant
kleinesap I guess you could argue that there is some handwaving going on here. RA (WACC) is equal to a weighted average of the returns of debt and equity and then they use this equation to solve for RE, so you're right WACC has to remain the same even when D/E changes. Maybe it's better to think of the pie model. There are 2 ways that the value of the firm can change, 1) a change in cash flow or 2) a change in the WACC. Neither happens by changing the capital structure.
on the one hand i see what you mean, I will continue looking into it, there is still a lot i need to figure out, thank you for your help
+kleinesap The MM propositions are not about taking Ko constant, it is about explaining why Ko is constant and proving it that capital structure is irrelevant by explaining it through the concept of Arbitrage. Hope u got some clarity.
+Ronald Moy Would you be kind enough to clarify why the WACC stays constant despite a change in capital structure? because your calculation of your new RE is based on the same WACC and therefore you are bound to get back the same WACC value when you plug back the new RE into the equation, which is kind of a chicken-and-egg scenario. Is there a reason why you can make the assumption that WACC stays constant? I can understand why cash flows stay constant but not WACC since it contains both cost of debt and equity. Thanks so much!
I'm a bit confused and would really appreciate help on this quesion
I don't get this concept.
An unlevered firm is only financed by equity and has no debt
The wacc is a weighted average of the companys debt and equity financing and the cost to debt holders/ investors
Doesn't the WACC include debt? So why did you use the WACC as the Ra in your example? Isn't the Ra the unlevered Re?
Ra is just the notation I used for WACC. I used the example presented in Essentials of Corporate Finance, by Ross, Westerfield and Jordan to explain the concept. Ra would be the unlevered Re if D=0.
Ronald Moy
Thank you very much Sir.
If you don't mind I have but one more question that is really confusing me.
Ra is the firms business risk so then it follows that the wacc in this case is the business risk. Intuitively that does not make much sense to me as I would think the WACC would pertain to financial risk. I was hope you may help clarify that for me a bit more.
Thanks again for your time
Why in Case 1 interest paid on debt doesn`t affect cash flow (value of the firm)?
In this case, the firm doesn't have anymore before tax cash flow, but what about after tax cash flow? When interest payments are tax deductible, the firm's after tax cash flow increases with the use of debt because the firm pays less taxes when it uses debt instead of equity. Because there are no taxes, there is no tax advantage to using debt. If you use debt to finance the firm you make interest payments. If you use stock, you have to pay stockholders a dividend and the share price will rise less than if the firm didn't pay a dividend. Shareholders don't really care in this case, because they can create their own leverage by borrowing to buy shares if the firm uses all equity to finance the firm. If the firm uses debt and a shareholder doesn't like the use of leverage, he can buy some of the company's bonds to offset this effect.
Thanks, needed to clarify this for my exams.
Thank you so much for this. your videos have helped me understand M&M's theorem more than reading their actual paper did.
your a fantastic teacher. thank you
Is this theory relevant to whole cost of capital?
It's more of a theoretical analysis that helps us to understand the issues of cost of capital and capital structure.
great explanation!
Thank you so much for this great explanation!
Very good 👍
Wow this is brilliant.!
you did not change the 15% to 0.15
The best explanation! tks
thank you so much! well explained
thank you so much!!!!
excel calcuration not very clear (invisible)
Thank you !