Chapter 14

Capital Structure Decisions: Part I

ANSWERS TO BEGINNINGO!C"APTER #$ESTIONS
Preface to Answers: Students often regard capital structure as being the most
difficult topic covered in this text. The empirical evidence on the effects
of capital structure are far from definitive, and the theory is controversial.
Academicians generally focus on market values, which are theoretically
correct, while many financial executives focus on book values, which are
theoretically uestionable but in some ways easier to deal with. !e wrestled
with this issue, and decided to base our "xcel model strictly on market
values. This led us to use an iterative solution process, which gets
complicated. #ur better students follow along and like the approach, because
everything works out nicely. $owever, our weaker and%or la&ier students don't
concentrate and get lost. !e went through the model in class, as it explains
the essential capital structure issues relatively well and also illustrates
the power of computer modeling. $owever, other instructors might prefer to
take a less rigorous approach and skip the "xcel model.
()*( +usiness risk is the risk inherent in the firm's operating income. ,t
is measured by the standard deviation of expected future operating
income. ,t is affected by many factors, including the firm's ability to
raise prices if costs increase, the extent to which sales can be
predicted, and operating leverage, which reflects the use of fixed
costs, or costs that do not decline with decreases in sales. ,f a firm
uses more operating leverage than an otherwise identical second firm,
then, other things held constant, its operating income and the rate of
return on assets will be less predictable, which suggests greater
business risk. The higher business risk would affect both bondholders
and stockholders, although the effect on bondholders is mitigated if the
firm uses relatively little debt. The first part of the +#- spreadsheet
model illustrates this point.
.enerally, higher operating leverage is correlated with higher
expected operating income and higher returns on invested capital.
.enerally speaking, since more operating leverage means more risk, then
a firm would not increase its operating leverage /through capital
budgeting decisions0 unless that resulted in higher expected returns.
$owever, the analysis can be more complicated. ,n the preceding
paragraph we implicitly assumed that the firm's sales are independent of
its use of operating leverage. $owever, this might not be true. $igher
fixed costs are generally accompanied by lower variable costs, and
producers with low variable costs can, under certain conditions, achieve
a monopoly position by doing the following: /(0 -harge a price that is
above their own /low0 variable cost but below the variable costs of
other producers. /10 The high cost producers find themselves in a bind.
,f they do not match the low*cost producers' prices, they will lose
market share, but if they do match this price, they will lose big*time
because they will not even be covering their variable costs. /20 Thus,
the high*cost producers can be driven from the market, leaving the low*
cost producer in a monopoly position in which it can raise its price and
. Answers and Solutions: 14 1
then earn very high rates of return. This situation is illustrated in
the model.
#ur conclusion from all this is that increasing operating leverage
generally increases both business risks and expected returns, but this
condition may not be true if other firms with low variable costs are
willing to use predatory pricing in order to achieve a monopoly
position. Therefore, it is important that strategic cost and market
conditions be analy&ed. Spreadsheet models can help in this regard.

()*1 3inancial leverage relates to the use of fixed charge securities /debt
and preferred stock0. Since the charges associated with debt and
preferred are fixed, they do not decline when sales and operating
profits decline. Therefore, the more debt and preferred the firm uses,
the greater the risk borne by the common stockholders
,f the firm is exposed to a great deal of business risk, then its
operating income is sub4ect to uncertainty, and its investors will be
exposed to uite a bit of risk. ,f it then piles on a lot of financial
leverage, its already high business risk will be concentrated on its
stockholders, exposing them to a great deal of risk. +ondholders' risks
are also increased by both types of leverage. !ith more financial
leverage, there will be higher fixed charges to be paid out of whatever
operating income the firm has, and this means a lower times interest
earned ratio, which is one way of measuring the riskiness of debt. The
+#- shows, for an illustrative firm, how the T," is affected by
financial leverage.
5anagers can control their financial leverage, at least initially,
although leverage will change once the firm is up and running due to
changes in the market value of its debt and euity. 5anagers can also
control operating leverage to a certain extent, although in most
industries efficiency reuires at least a certain amount of operating
leverage. ,n the +#- model, we assume that the firm can operate with
either Plan A or Plan +, although we eventually assume that Plan A is
ruled out.
6egarding financial leverage, the firm can establish a target capital
structure and then plan to finance according to the target. $owever,
once the firm is in business, with a given amount of debt and some
number of shares outstanding, changes in its sales and earnings, and
also in capital market rates, can lead to departures from the target.
,f things go well, the value of the euity will increase, and that will
lead to a lower market value debt ratio. Then, the firm could borrow,
use the funds to retire stock, and lower the debt ratio to the target
level. $owever, if conditions deteriorate, causing euity values go
down and the debt ratio goes up, it may be extremely difficult to get
back to the target. Still, in a planning sense, firms can control their
capital structures and financial leverage.
()*2 5odigliani and 5iller are 7obel Pri&e winning financial economists who
did pioneering work on capital structure theory. They concluded that,
under a specific set of assumptions, including the assumption of no
taxes, capital structure is irrelevant because it has no effect on
either the !A-- or the value of a firm. !hen they add in corporate
taxes, their model leads to the conclusion that a firm's cost of capital
is minimi&ed, and its value maximi&ed, at (889 debt.

Answers and Solutions: 14 %
()*) ,f managers thought 55 were correct:i.e., that their assumptions were
true:then they would use (889 debt. Since firms do not generally set
capital structures with (889 debt, this demonstrates that executives see
a problem with the pure 55 model. 55's assumptions are clearly not
correct, hence no one should expect the results of their model to be
correct in the real world. Still, the beauty of 55's work is that it
shows us what does cause capital structure to affect !A-- and value:
things like taxes, brokerage costs, bankruptcy, and so on.
()*; The trade*off theory modifies 55 and brings in the effects of
bankruptcy, taxes, and so forth. !hereas 55 produce precise results
under specific assumptions, the trade*off theory produces nebulous,
imprecise results. Still, the trade*off results are more consistent
with real world observations than are the 55 results. See the graph on a
separate tab in the model /3igure 10 for the relationship between cost
of capital and capital structure nder the trade*off theory, and 3igure (
toward the bottom of the <5ain 5odel0 for value versus capital structure
under 55 and trade*off. !e don't show a graph of stock price versus
capital structure, but one of the data tables in the model shows that
the firm's stock price is maximi&ed at )89 debt, where the stock's price
is =(>.)>, up from =(; if no debt is used. ,n the case of an ,P#, which
is the first situation analy&ed in the model, the stock price is set at
=(; and then different percentages of the company are given to outside
investors to bring in the needed euity capital.
55's model leads to the conclusion that firms should finance entirely
with debt, whereas the tradeoff model reaches the more logical and
empirically correct conclusion that firms should not finance entirely
with debt, and that there is some optimal capital structure /which
varies from firm to firm depending on its operating conditions and its
access to debt and euity capital markets and the cost of those funds0.
()*> !hen companies finance with stock, they bring in new investors. ,f
management thinks that things in the future will be a lot better, they
would not want to bring in new euity investors, as this would mean more
shares outstanding and a dilution of the current euity. So, if
management sees good times ahead, the preferred financing vehicle is
debt. Therefore, if a firm announces that it plans to sell a new stock
issue, investors take this as a negative signal:a signal that things
might now go very well in the future. #n the other hand, the
announcement of a large debt offering is taken as a positive signal.
-onseuently, when a firm announces a significant new stock offering,
its price typically declines, whereas the announcement of a debt
offering is likely to lead to a stock price increase.
?nowing this, managers are reluctant to finance with new stock. This
influences dividend policy, causing companies to retain more earnings so
as to build euity that will support additional debt offerings at times
when new capital is needed. ,n the financial 4argon, a strong balance
sheet /i.e., a relatively low debt ratio0 provides financial
flexibility, which means the ability to raise capital as debt if the
need arises.
The end result is that signaling considerations cause companies to
carry a lower debt ratio during <normal@ times than the trade*off theory
would suggest as the optimal.
. Answers and Solutions: 14 &
The differential knowledge between stockholders and managers that
leads to the signaling effect is called asymmetric information in the
finance literature.
()*A The optimal capital structure is the debt%euity mix that causes the
firm's value to be maximi&ed. This same structure also minimi&ed the
!A--.
()*B The primary focus should be on the market value capital structure for a
number of reasons:
3irms are interested in maximi&ing market values, so decisions should
be based on market values and the effects of different actions on those
values.
+ook values measure historical costs, whereas market values reflect
expected cash flows. #ftentimes, book values are really meaningless in
the sense that an asset with a book value /historical cost0 of =(
million could actually be worth =8 or as much as =(88 million. 5arket
values are simply more relevant than book values for financial
management decision purposes.
5arket value weights should be used when determining the !A-- for use
in capital budgeting.
+ook values are needed for tax purposes, but not for decision
purposes except as they affect cash flows due to tax considerations.
,f a firm has primarily intangible assets such as intellectual
property, then its book value may be truly meaningless. #n the other
hand, if a firm's assets consist of tangible assets such as real estate
or inventories, and if those assets' market values are close to their
book values, then analysts may focus on book values because they are
easier to uantify. $owever, in this instance, it really doesn't matter
if one uses book or market values, because book values are a good proxy
for market values. $owever, when book and market values depart, no
competent analyst pays much attention to book value figures.
!e should note that the +#- model is set up entirely on the basis of
market values. !e first did the analysis using book values, but nothing
worked out right in the sense that the capital structure that minimi&ed
!A-- was not the capital structure that maximi&ed the firm's value and
stock price. ,t was easier to work with book values, but we 4ust didn't
get consistent and correct answers as to the appropriate capital
structure. So, we finally gave up and set up the model correctly, using
market values. !e felt that the added complexity was worth the effort.
!e should also note that technology is making it increasingly
feasible to <do things right.@ !ith "xcel, we set up an iterating model
that worked out the market value relationships. A few years ago it
would have been far more difficult to do this. Students coming out of
school today should be learning how to use the available technology to
make technically correct decisions.
3inally, we should note that the tab labeled 5*+ in the model /also
shown in the output at the end of these answers0 shows the errors in
!A--s based on book values. ,f the market and book values of the firm's
securities are approximately eual, there is no error, but as market and
book values diverge, errors become uite large. Since the average SCP
company sells at about ) time its book value, this suggests that a !A--
based on a book value capital structure will be about 289 below the
correct !A--. This downward bias results from giving too little weight
to higher cost common euity.
Answers and Solutions: 14 4
()*D 3inance theory suggests that firms should use at least some debt in
order to gain the benefits of interest deductibility and perhaps other
advantages. 5ost firms do indeed use some debt. So, if a firm
announced a recapitali&ation in which it will issue some debt and use
the proceeds to retire common euity, investors would probably respond
favorably, raising the firm's stock price. #f course, there is such a
thing as too much leverage, but if the firm conducted an appropriate
analysis, it would probably be safe to assume that the stock price would
rise after the announcement.
. Answers and Solutions: 14 '
ANSWERS TO ENDO!C"APTER #$ESTIONS
()*( a. -apital structure is the manner in which a firm's assets are
financedE that is, the right*hand side of the balance sheet. -apital
structure is normally expressed as the percentage of each type of
capital used by the firm**debt, preferred stock, and common euity.
+usiness risk is the risk inherent in the operations of the firm,
prior to the financing decision. Thus, business risk is the
uncertainty inherent in a total risk sense, future operating income,
or earnings before interest and taxes /"+,T0. +usiness risk is
caused by many factors. Two of the most important are sales
variability and operating leverage. 3inancial risk is the risk added
by the use of debt financing. Febt financing increases the
variability of earnings before taxes /but after interest0E thus,
along with business risk, it contributes to the uncertainty of net
income and earnings per share. +usiness risk plus financial risk
euals total corporate risk.
b. #perating leverage is the extent to which fixed costs are used in a
firm's operations. ,f a high percentage of a firm's total costs are
fixed costs, then the firm is said to have a high degree of operating
leverage. #perating leverage is a measure of one element of business
risk, but does not include the second ma4or element, sales
variability. 3inancial leverage is the extent to which fixed*income
securities /debt and preferred stock0 are used in a firm's capital
structure. ,f a high percentage of a firm's capital structure is in
the form of debt and preferred stock, then the firm is said to have a
high degree of financial leverage. The breakeven point is that level
of unit sales at which costs eual revenues. +reakeven analysis may
be performed with or without the inclusion of financial costs. ,f
financial costs are not included, breakeven occurs when "+,T euals
&ero. ,f financial costs are included, breakeven occurs when "+T
euals &ero.
c. 6eserve borrowing capacity exists when a firm uses less debt under
<normal@ conditions than called for by the tradeoff theory. This
allows the firm some flexibility to use debt in the future when
additional capital is needed.
()*1 +usiness risk refers to the uncertainty inherent in pro4ections of
future 6#"
G
.
()*2 3irms with relatively high nonfinancial fixed costs are said to have a
high degree of operating leverage.
()*) #perating leverage affects "+,T and, through "+,T, "PS. 3inancial
leverage has no effect on "+,T**it only affects "PS, given "+,T.
()*; ,f sales tend to fluctuate widely, then cash flows and the ability to
service fixed charges will also vary. Such a firm is said to have high
business risk. -onseuently, there is a relatively large risk that the
Answers and Solutions: 14 (
firm will be unable to meet its fixed charges, and interest payments are
fixed charges. As a result, firms in unstable industries tend to use
less debt than those whose sales are sub4ect to only moderate
fluctuations.
()*> Public utilities place greater emphasis on long*term debt because they
have more stable sales and profits as well as more fixed assets. Also,
utilities have fixed assets which can be pledged as collateral.
3urther, trade firms use retained earnings to a greater extent, probably
because these firms are generally smaller and, hence, have less access
to capital markets. Public utilities have lower retained earnings
because they have high dividend payout ratios and a set of stockholders
who want dividends.
()*A "+,T depends on sales and operating costs. ,nterest is deducted from
"+,T. At high debt levels, firms lose business, employees worry, and
operations are not continuous because of financing difficulties. Thus,
financial leverage can influence sales and costs, and hence "+,T, if
excessive leverage is used.
()*B The tax benefits from debt increase linearly, which causes a continuous
increase in the firm's value and stock price. $owever, financial
distress costs get higher and higher as more and more debt is employed,
and these costs eventually offset and begin to outweigh the benefits of
debt.
. Answers and Solutions: 14 )
SO*$TIONS TO ENDO!C"APTER PROB*E+S
()*( a. $ere are the steps involved:
/(0 Fetermine the variable cost per unit at present, H:
Profit I P/J0 * 3- * H/J0
=;88,888 I /=(88,8880/;80 * =1,888,888 * H/;80
;8/H0 I =1,;88,888
H I =;8,888.
/10 Fetermine the new profit level if the change is made:
7ew profit I P
1
/J
1
0 * 3-
1
* H
1
/J
1
0
I =D;,888/A80 * =1,;88,888 * /=;8,888 * =(8,8880/A80
I =(,2;8,888.
/20 Fetermine the incremental profit:
Profit I =(,2;8,888 * =;88,888 I =B;8,888.
/)0 "stimate the approximate rate of return on new investment:
6#, I Profit%,nvestment I =B;8,888%=),888,888 I 1(.1;9.
Since the 6#, exceeds the (; percent cost of capital, this analysis
suggests that the firm should go ahead with the change.
Answers and Solutions: 14 ,
b. ,f we measure operating leverage by the ratio of fixed costs to total
costs at the expected output, then the change would increase
operating leverage:
#ld:
0 J / H 3-
3-
+
I
888 , ;88 , 1 = 888 , 888 , 1 =
888 , 888 , 1 =
+
I )).))9.
7ew:
0 J / H 3-
3-
1 1 1
1
+
I
888 , B88 , 1 = 888 , ;88 , 1 =
888 , ;88 , 1 =
+
I )A.(A9.
The change would also increase the breakeven point:
#ld: J
+"
I
H P
3

I
888 , ;8 = 888 , (88 =
888 , 888 , 1 =

I )8 units.
7ew: J
+"
I
888 , )8 = 888 , D; =
888 , ;88 , 1 =

I );.); units.
$owever, one could measure operating leverage in other ways, say by
degree of operating leverage:
#ld: F#K I
3 0 H P / J
0 H P / J

I
888 , 888 , 1 = 0 888 , ;8 /= ;8
0 888 , ;8 /= ;8

I ;.8.
7ew: The new F#K, at the expected sales level of A8, is
888 , ;88 , 1 = 0 888 , ;; /= A8
0 888 , )8 = 888 , D; /= A8

I 1.B;.
The problem here is that we have changed both output and sales price,
so the F#Ks are not really comparable.
c. ,t is impossible to state uneuivocally whether the new situation
would have more or less business risk than the old one. !e would
need information on both the sales probability distribution and the
uncertainty about variable input cost in order to make this
determination. $owever, since a higher breakeven point, other things
held constant, is more risky, the change in breakeven points**and
also the higher percentage of fixed costs**suggests that the new
situation is more risky.
. Answers and Solutions: 14 -
()*1 a. "xpected 6#" for 3irm -:
6#"
-
I /8.(0/*;.890 L /8.10/;.890 L /8.)0/(;.890
L /8.10/1;.890 L /8.(0/2;.890 I (;.89.
7ote: The distribution of 6#"
-
is symmetrical. Thus, the answer to
this problem could have been obtained by simple inspection.
Standard deviation of 6#" for 3irm -:
9. 8 . (( (18 )8 18 8 18 )8 0 18 / ( . 8 0 (8 / 1 . 8 0 8 / ) . 8 0 (8 / 1 . 8 0 18 / ( . 8
0 8 . (; 8 . 2; / ( . 8 0 8 . (; 8 . 1; / 1 . 8 0 8 . (; 8 . (; / ) . 8 0 8 . (; 8 . ; / 1 . 8 0 8 . (; 8 . ; / ( . 8
1 1 1 1 1
1 1 1 1 1
-
= = + + + + = + + + + =
+ + + + =
b. According to the standard deviations of 6#", 3irm A is the least
risky, while - is the most risky. $owever, this analysis does not
take into account portfolio effects**if -'s 6#" goes up when most
other companies' 6#"s decline /that is, its beta is negative0, its
apparent riskiness would be reduced.
c. 3irm A's
6#"
I
+"P
I ;.;9. Therefore, 3irm A uses no financial
leverage and has no financial risk. 3irm + and 3irm - have
6#"
M

+"P
, and hence both use leverage. 3irm - uses the most leverage
because it has the highest
6#"
*
+"P
I measure of financial risk.
$owever, 3irm -'s stockholders also have the highest expected 6#".
()*2 a. #riginal value of the firm /F I =80:
H I F L S I 8 L /=(;0/188,8880 I =2,888,888.
#riginal cost of capital:
!A-- I w
d
r
d
/(*T0 L w
e
r
s
I 8 L /(.80/(890 I (89.
!ith financial leverage /w
d
I2890:
!A-- I w
d
r
d
/(*T0 L w
e
r
s
I /8.20/A90/(*8.)80 L /8.A0/((90 I B.D>9.
+ecause growth is &ero, the value of the company is:
H I . 286 . 214 , 348 , 3 $
0896 . 0
) 40 . 0 1 )( 000 , 500 ($
WACC
) T 1 )( EBIT (
WACC
FCF
=

= .
,ncreasing the financial leverage by adding =D88,888 of debt results
in an increase in the firm's value from =2,888,888 to =2,2)B,1().1B>.
Answers and Solutions: 14 1.
b. Gsing its target capital structure of 289 debt, the company must have
debt of:
F I w
d
H I 8.28/=2,2)B,1().1B>0 I =(,88),)>).1B>.
Therefore, its debt value of euity is:
S I H N F I =1,2)2,A;8.
Alternatively, S I /(*w
d
0H I 8.A/=2,2)B,1().1B>0 I =1,2)2,A;8.
The new price per share, P, is:
P I OS L /F N F
8
0P%n
8
I O=1,2)2,A;8 L /=(,88),)>).1B> N 80P%188,888
I =(>.A)(.
c. The number of shares repurchased, Q, is:
Q I /F N F
8
0%P I =(,88),)>).1B> % =(>.A)( I >8,888.1;> >8,888.
The number of remaining shares, n, is:
n I 188,888 N >8,888 I ()8,888.
,nitial position:
"PS I O/=;88,888 N 80/(*8.)80P % 188,888 I =(.;8.
!ith financial leverage:
"PS I O/=;88,888 N 8.8A/=(,88),)>).1B>00/(*8.)80P % ()8,888
I O/=;88,888 N =A8,2(1.;0/(*8.)80P % ()8,888
I =1;A,B(1.; % ()8,888 I =(.B)1.
Thus, by adding debt, the firm increased its "PS by =8.2)1.
d. 289 debt: T," I
,
"+,T
I
5 . 312 , 70 $
EBIT
.
Probability T,"
8.(8 / (.)10
8.18 1.B)
8.)8 A.((
8.18 ((.2B
8.(8 (;.>)
The interest payment is not covered when T," R (.8. The probability
of this occurring is 8.(8, or (8 percent.
. Answers and Solutions: 14 11
()*) a. Present situation /;89 debt0:
!A-- I w
d
r
d
/(*T0 L w
e
r
s
I /8.;0/(890/(*8.(;0 L /8.;0/()90 I ((.1;9.
H I
1125 . 0
) 15 . 0 1 )( 24 . 13 ($
WACC
) T 1 )( EBIT (
WACC
FCF
=

= I =(88 million.
A8 percent debt:
!A-- I w
d
r
d
/(*T0 L w
e
r
s
I /8.A0/(190/(*8.(;0 L /8.20/(>90 I ((.D)9.
H I
1194 . 0
) 15 . 0 1 )( 24 . 13 ($
WACC
) T 1 )( EBIT (
WACC
FCF
=

= I =D).1;; million.
28 percent debt:
!A-- I w
d
r
d
/(*T0 L w
e
r
s
I /8.20/B90/(*8.(;0 L /8.A0/(290 I ((.()9.
H I
1114 . 0
) 15 . 0 1 )( 24 . 13 ($
WACC
) T 1 )( EBIT (
WACC
FCF
=

= I =(8(.812 million.
()*; a. +"A's unlevered beta is b
G
Ib
K
%/(L /(*T0/F%S00I(.8%/(L/(*8.)80/18%B800
I 8.BA8.
b. b
K
I b
G
/( L /(*T0/F%S00.
At )8 percent debt: b
K
I 8.BA /( L 8.>/)89%>8900 I (.1(B.
r
S
I > L (.1(B/)0 I (8.BA19
c. !A-- I w
d
r
d
/(*T0 L w
e
r
s
I /8.)0/D90/(*8.)0 L /8.>0/(8.BA190 I B.>B29.
H I
08683 . 0
) 4 . 0 1 )( 933 . 14 ($
WACC
) T 1 )( EBIT (
WACC
FCF
=

= I =(82.(BB million.
Answers and Solutions: 14 1%
()*> Tax rate I )89 r
63
I ;.89
b
G
I (.1 r
5
N r
63
I >.89
3rom data given in the problem and table we can develop the following
table:
F%A "%A F%" r
d
r
d
/( N T0 Keveraged
beta
a
r
s
b
!A--
c
8.88 (.88 8.8888 A.889 ).189 (.18 (1.189 (1.189
8.18 8.B8 8.1;88 B.88 ).B8 (.2B (2.1B ((.;B
8.)8 8.>8 8.>>>A (8.88 >.88 (.>B (;.8B ((.);
8.>8 8.)8 (.;888 (1.88 A.18 1.1B (B.>B ((.AD
8.B8 8.18 ).8888 (;.88 D.88 ).8B 1D.)B (2.(8
7otes:
a
These beta estimates were calculated using the $amada euation, b I
b
G
O( L /( N T0/F%"0P.
b
These r
s
estimates were calculated using the -AP5, r
s
I r
63
L /r
5
N
r
63
0b.
c
These !A-- estimates were calculated with the following euation:
!A-- I w
d
/r
d
0/( N T0 L /w
c
0/r
s
0.
The firm's optimal capital structure is that capital structure which
minimi&es the firm's !A--. "lliott's !A-- is minimi&ed at a capital
structure consisting of )89 debt and >89 euity. At that capital
structure, the firm's !A-- is ((.);9.
. Answers and Solutions: 14 1&
SO*$TION TO SPREADS"EET PROB*E+
()*A The detailed solution for the problem is available both on the
instructor's resource -F*6#5 /in the file Solution for Ch 14 P7 Build a
Model.xls0 and on the instructor's side of the web site,
http://brigham.swcollege.com.
Answers and Solutions: 14 14
+INI CASE
ASSUME YOU HAVE JUST BEE H!"E# AS BUS!ESS MAA$E" O% &!''A&A(A)E* A &!''A
"ESTAU"AT (O)ATE# A#JA)ET TO )AM&US. THE )OM&AY+S EB!T ,AS -.//*/// (AST
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Mini Case: 14 1'
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Mini Case: 14 1(
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Mini Case: 14 1,
E. O, )OS!#E" THE %A)T THAT EB!T !S OT 4O, ,!TH )E"TA!TY* BUT
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EA)H STATE O% THE E)OOMY* A# THE )A()U(ATE THE E0&E)TE# VA(UES.
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Mini Case: 14 1-
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Mini Case: 14 %.
$. ,!TH THE ABOVE &O!TS ! M!#* O, )OS!#E" THE O&T!MA( )A&!TA(
ST"U)TU"E %O" &!''A&A(A)E.
$. 172 %O" EA)H )A&!TA( ST"U)TU"E U#E" )OS!#E"AT!O* )A()U(ATE THE (EVE"E#
BETA* THE )OST O% E3U!TY* A# THE ,A)).
AS,E": 55 T$"#6S ,5PK,"S T$AT +"TA -$A7."S !,T$ K"H"6A.". +
G
,S T$" +"TA
#3 A 3,65 !$"7 ,T $AS 7# F"+T /T$" G7K"H"6"F +"TA. $A5AFA'S "JGAT,#7
P6#H,F"S T$" +"TA #3 A K"H"6"F 3,65: +
K
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O( L /( * T0/F%S0P. 3#6
"QA5PK", T# 3,7F T$" -#ST #3 "JG,TS 3#6 !
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I 189, !" 3,6ST GS"
$A5AFA'S "JGAT,#7 T# 3,7F +"TA:
+
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I (.8 O( L /(*8.)0 /189 % B890 P
I (.(;
T$"7 GS" -AP5 T# 3,7F T$" -#ST #3 "JG,TS:
6
S
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63
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!
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89 8.88 (.888 (1.889
189 8.1; (.(;8 (1.D89
289 8.)2 (.1;A (2.;)9
)89 8.>A (.)88 ().)89
;89 (.88 (.>88 (;.>89
7"QT, 3,7F T$" !A--. 3#6 "QA5PK", T$" !A-- 3#6 !
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I 189 ,S:
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!A-- I 8.1 /( N 8.)0 /B90 L 8.B /(1.D90
!A-- I ((.1B9

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89 8.89 (1.889 (1.889
189 B.89 (1.D89 ((.1B9
289 B.;9 (2.;)9 ((.8(9
)89 (8.89 ().)89 ((.8)9
;89 (1.89 (;.>89 ((.)89
Mini Case: 14 %1
$. 192 O, )A()U(ATE THE )O"&O"ATE VA(UE* THE VA(UE O% THE #EBT THAT ,!(( BE
!SSUE#* A# THE "ESU(T!$ MA"4ET VA(UE O% E3U!TY.
AS,E": 3#6 "QA5PK" T$" -#6P#6AT" HAKG" 3#6 !
F
I 189 ,S:
H I 3-3 % /!A--*.0
.I8, S# ,7H"ST5"7T ,7 -AP,TAK ,S U"6#E S# 3-3 I 7#PAT I "+,T /(*T0.
,7 T$,S "QA5PK", 7#PAT I /=;88,8880/(*8.)80 I =288,888.

GS,7. T$"S" HAKG"S, H I =288,888 % 8.((1B I =1,>;D,;A).
6"P"AT,7. T$,S 3#6 AKK -AP,TAK ST6G-TG6"S .,H"S T$" 3#KK#!,7. TA+K":
!
F
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89 (1.889 =1,;88,888
189 ((.1B9 =1,>;D,;A)
289 ((.8(9 =1,A1),AD>
)89 ((.8)9 =1,A(A,2D(
;89 ((.)89 =1,>2(,;AD
AS T$,S S$#!S, HAKG" ,S 5AQ,5,U"F AT A -AP,TAK ST6G-TG6" !,T$ 289
F"+T.
$. 1=2 )A()U(ATE THE "ESU(T!$ &"!)E &E" SHA"E* THE UMBE" O% SHA"ES
"E&U")HASE#* A# THE "EMA!!$ SHA"ES.
AS,E": 3,6ST,3,7F T$" F#KKA6 HAKG" #3 F"+T A7F "JG,TS. 3#6 "QA5PK", 3#6 !
F

I 189, T$" F#KKA6 HAKG" #3 F"+T ,S:
F I !
F
H I 8.1 /=1,>;D,;A)0 I =;2(,D(;.
!" -A7 T$"7 3,7F T$" F#KKA6 HAKG" #3 "JG,TS:
S I H N F
S I =1,>;D,;A) * =;2(,D(; I =1,(1A,>;D.
!" 6"P"AT T$,S P6#-"SS 3#6 AKK T$" -AP,TAK ST6G-TG6"S.
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89 =8 =1,;88,888
189 =;2(,D(; =1,(1A,>>8
289 =B(A,)2D =(,D8A,2;A
)89 =(,8B>,D;A =(,>28,)2;
;89 =(,2(;,ABD =(,2(;,ABD
7#T": T$"S" A6" 6#G7F"FE S"" -$ () 5,7, -AS".QKS 3#6 3GKK
-AK-GKAT,#7S.
7#T,-" T$AT T$" HAKG" #3 T$" "JG,TS F"-K,7"S AS 5#6" F"+T ,S ,SSG"F,
+"-AGS" F"+T ,S GS"F T# 6"PG6-$AS" ST#-?. +GT T$" T#TAK !"AKT$ #3
S$A6"$#KF"6S ,S T$" HAKG" #3 ST#-? A3T"6 T$" 6"-AP PKGS T$" -AS$
6"-",H"F ,7 6"PG6-$AS", A7F T$,S T#TAK .#"S GP /,T ,S "JGAK T#
-#6P#6AT" HAKG" #7 "A6K,"6 SK,F"0.
Mini Case: 14 %%
T$" 3,65 ,SSG"S F"+T, !$,-$ -$A7."S ,TS !A--, !$,-$ -$A7."S HAKG".
T$" 3,65 T$"7 GS"S F"+T P6#-""FS T# 6"PG6-$AS" ST#-?. T$" ST#-?
P6,-" -$A7."S A3T"6 F"+T ,S ,SSG"F, +GT F#"S 7#T -$A7." FG6,7. A-TGAK
6"PG6-$AS" /#6 A6+,T6A." ,S P#SS,+K"0. T$" ST#-? P6,-" A3T"6 F"+T ,S
,SSG"F +GT +"3#6" ST#-? ,S 6"PG6-$AS"F 6"3K"-TS S$A6"$#KF"6 !"AKT$,
!$,-$ ,S T$" SG5 #3 T$" ST#-? A7F T$" -AS$ PA,F ,7 6"PG6-$AS".
3#6 "QA5PK", T# 3,7F T$" ST#-? P6,-" 3#6 !
F
I 189, K"T F
8
A7F 7
8

F"7#T" F"+T A7F #GTSTA7F,7. S$A6"S +"3#6" T$" 6"-AP. F * F
8
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T# -AS$ T$AT !,KK +" GS"F T# 6"PG6-$AS" ST#-?. S L /F * F
8
0 ,S T$"
!"AKT$ #3 S$A6"$#KF"6S' A3T"6 T$" F"+T ,S ,SSG"F +GT ,55"F,AT"KS
+"3#6" T$" 6"PG6-$AS". !" -A7 "QP6"S T$" ST#-? P6,-" P"6 S$A6" P6,#6
T# T$" 6"PG6-$AS", P, 3#6 !
F
I 189, AS:
P I OS L /F N F
8
0P%7
8
.
P I O=1,(1A,>>8 L /=;2(,D(; N 80P % (88,888
P I =1>.;D> P"6 S$A6".
T$" 7G5+"6 #3 S$A6"S 6"PG6-$AS"F ,S:
V 6"PG6-$AS"F I /F * F
8
0 % P
V 6"P. I /=;2(,D(; N 80 % =1>.;D>
I 18,888.
T$" 7G5+"6 #3 6"5A,7,7. S$A6"S A3T"6 T$" 6"PG6-$AS" ,S:
V 6"5A,7,7. I 7 I S % P
7 I =1,(1A,>>8 % =1>.;D>
I B8,888.
!" -A7 APPKS T$,S SA5" P6#-"FG6" T# AKK T$" -AP,TAK ST6G-TG6"S G7F"6
-#7S,F"6AT,#7.
V S$A6"S V S$A6"S
!
F
P 6"PG6-$. 6"5A,7,7.
89 =1;.88 8 (88,888
189 =1>.>8 18,888 B8,888
289 =1A.1; 28,888 A8,888
)89 =1A.(A )8,888 >8,888
;89 =1>.21 ;8,888 ;8,888
H. )OS!#E"!$ O(Y THE )A&!TA( ST"U)TU"ES U#E" AA(YS!S* ,HAT !S
&!''A&A(A)E+S O&T!MA( )A&!TA( ST"U)TU"E@
AS,E": T$" #PT,5AK -AP,TAK ST6G-TG6" ,S 3#6 !
F
I 289. T$,S .,H"S T$"
$,.$"ST -#6P#6AT" HAKG", T$" K#!"ST !A--, A7F T$" $,.$"ST ST#-? P6,-"
P"6 S$A6". +GT 7#T,-" T$AT !
F
I )89 ,S H"6S S,5,KA6 T# T$" #PT,5AK
S#KGT,#7E ,7 #T$"6 !#6FS, T$" #PT,5AK 6A7." ,S P6"TTS 3KAT.
Mini Case: 14 %&
!. ,HAT OTHE" %A)TO"S SHOU(# MAA$E"S )OS!#E" ,HE SETT!$ THE TA"$ET
)A&!TA( ST"U)TU"E@
AS,E": 5A7A."6S S$#GKF AKS# -#7S,F"6 T$" F"+T 6AT,#S #3 #T$"6 3,65S ,7 T$"
,7FGST6S, P6# 3#65A -#H"6A." 6AT,#S AT F,33"6"7T -AP,TAK ST6G-TG6"S
G7F"6 F,33"6"7T "-#7#5,- S-"7A6,#S, K"7F"6 A7F 6AT,7. A."7-S
ATT,TGF"S /,."., T$" ,5PA-T #7 +#7F 6AT,7.S0, 6"S"6H" +#66#!,7.
-APA-,TS, T$" "33"-TS #7 -#7T6#K /,."., F#"S T$" -AP,TAK ST6G-TG6"
5A?" ,T "AS,"6 #3 $A6F"6 3#6 A7 #GTS,F"6 T# TA?" #H"6 T$" 3,650, T$"
3,65'S TSP"S #3 ASS"TS /,."., A6" T$"S TA7.,+K", A7F $"7-" SG,TA+K"
AS -#KKAT"6AKW8, A7F T$" 3,65'S P6#T"-T"F TAQ 6AT"S.
Mini Case: 14 %4