Chapter 17 Capital Structure 17A-1

Appendix 17A Some Useful Formulas of Financial Structure

Definitions:
E(EBIT)  A perpetual expectation of cash operating income before interest and
taxes.
VU  Value of an unlevered firm.
VL  Value of levered firm.
B  Present value of debt.
S  Present value of equity.
RS  Cost of equity.
RB  Cost of debt capital.
R0  Cost of capital to an all-equity firm. In a world of no corporate
taxes, the weighted average cost of capital to a levered firm, RWACC, is
also equal to R 0. However, with corporate taxes, R 0 is above RWACC
for a levered firm.
Model I (No Tax):
E(EBIT)
VL  VU  ________
R 0

R S  R 0  (R 0  R B)  BS

www.mhhe.com/rwj
Model II (Corporate Tax, tC  0; No Personal Taxes, tS tB 0):

E[EBIT]  (1  tC) tC RB B
VL  _________________
R0  ______
RB  VU  tC B
RS  R0  (1  tC)  (R0  RB)  BS
Model III (Corporate Tax, tC  0; Personal Tax, tB  0; tS  0):

 (1  tC)  (1  tS)
VL  VU  1  ________________
(1  tB)
B


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