AN

INTRODUCTION
S Y N D I C AT E 8 Y P 5 6 C
E R L A N G G A D. M . 2 9 1 1 6 4 9 0

TO DEBT POLICY
MOCH. ARIEF RAHMAN 29116412
VIONNA ANGELICA 29116417

AND VALUE
YO S E F DA D I A . 2 9 1 1 6 4 4 0
#1 WHY DOES THE VALUE OF ASSET CHANGE? WHERE,
SPECIFICALLY, DO THE CHANGES OCCUR?
0% Debt / 25% Debt / 50% Debt /
Value of Assets
100% Equity 75% Equity 50% Equity By the increasing of debt, it causing the
Book value of debt
Book value of equity
0
$10,000
$2,500
$7,500
$5,000
$5,000
decreasing of WACC, then the value of
Market value of debt 0 $2,500 $5,000 asset will be increased.
Market value of equity $10,000 $8,350 $6,700
Pretax cost of debt 0.07 0.07 0.07 The changes occur at the WACC.
After tax cost of debt 0.0462 0.0462 0.0462
Market value weights of:
Debt 0 0.2304 0.4274
Equity 1 0.7696 0.5726
Unlevered of beta 0.8 0.8 0.8
Levered beta 0.8000 0.9581 1.1940
Risk-free rate 0.07 0.07 0.07
Market premium 0.086 0.086 0.086
Cost of equity 0.139 0.152 0.173
Weighted average cost of
13.88% 12.79% 11.86%
capital
EBIT $2,103 $2,103 $2,103
- Taxes (34%) $715.02 $715.02 $715.02
EBIAT $1,387.98 $1,387.98 $1,387.98
+ Depreciation $500 $500 $500
- Capital exp. $(500) $(500) $(500)
Free cash flow $1,387.98 $1,387.98 $1,387.98
Value of assets (FCF/WACC) $9,999.86 $10,849.84 $11,699.83
#2 AS THE FIRM LEVERS UP, HOW DOES THE INCREASE IN VALUE
GET APPORTIONED BETWEEN CREDITORS AND
SHAREHOLDERS?
0% Debt / 25% Debt / 50% Debt /
100% Equity 75% Equity 50% Equity
As the debt increase it effects value of debt Cash flow to creditors:
to be increased and value of equity to be Interest 0 $175 $350
Pretax cost of debt 0.07 0.07 0.07
decreased. Then it will cut down the Value of debt:
distribution of cash to the shareholder. (CF/rd) 0.00 $2,500 $5,000

The total of value of debt and value of equity Cash flow to shareholders:
EBIT $2,103 $2,103 $2,103
calculation must be equivalent with the value Interest 0 $(175) $(350)
of assets. Pretax profit $2,103 $1,928 $1,753
Taxes (34%) $715 $656 $596
Net income $1,388 $1,272 $1,157
Depreciation $500 $500 $500
Capital exp. $(500) $(500) $(500)
Debt amortiz. 0 0 0
Residual cash flow $1,387.98 $1,272.48 $1,156.98
Cost of equity $0.14 $0.15 $0.17
Value of equity (CF/re) $9,999.86 $8,349.87 $6,699.88
Value of equity plus value of debt $9,999.86 $10,849.87 $11,699.88
 #3 THEORY OF FRANCO MODIGLIANI AND MERTON
MILLER
0% Debt /
100% Equity
25% Debt /
75% Equity
50% Debt /
50% Equity As our calculation before,Value of assets
Pure business cash flows:
EBIT $2,103 $2,103 $2,103
is equal to value of debt plus value of
Taxes (34%) $(715) $(715) $(715) equity.
EBIAT $1,388 $1,388 $1,388
+ Depreciation
- Capital exp.
$500
$(500)
$500
$(500)
$500
$(500)
From the table we can see that the theory
Cash flow $1,388 $1,388 $1,388 of Franco Modigliani and Merton Miller is
Unlevered beta 0.8 0.8 0.8
Risk-free rate 0.07 0.07 0.07 proven, because value of assets = value of
Market premium
Unlevered WACC
0.086
0.1388
0.086
0.1388
0.086
0.1388 unlevered firm + value of debt tax shield.
Value of pure business flows:
(CF/Unlevered WACC) $10,000 $10,000 $10,000
Financing cash flows:
Interest 0 $175 $350
Tax Reduction 0 $60 $119
Pretax cost of debt 0.07 0.07 0.07

Value of financing effect:

(tax reduction/pretax cost of debt) 0 $850 $1,700
Total value (sum of values of pure
$10,000 $10,850 $11,700
business flows and financial effects)
#4 TOTAL VALUE OF EQUITY VS TOTAL VALUE
PER SHARE

We held EBIT constant so that we could

0% Debt / 25% Debt / 50% Debt /
see clearly the effect of financial changes 100% Equity 75% Equity 50% Equity
without getting them mixed up in the
effects of investment.The point is that, as Total market value of
equity
$9,999.86 $8,349.87 $6,699.88
the firm borrows and repurchases shares,
the total value of equity may decline, but Cash paid out $- $2,500 $5,000
Number of original
the price per share my rise. shares
1000 1000 1000

Total value per share $10.000 $10.850 $11.700

#5 WHY IS LEVERAGE GOOD FOR SHAREHOLDERS? IS LEVERAGING OR
UNLEVERAGING THE FIRM SOMETHING SHAREHOLDERS CAN DO FOR
THEMSELVES? IN WHAT SENSE SHOULD SHAREHOLDERS PAY A
PREMIUM FOR SHARES OF LEVERED COMPANIES?
Leverage is good for shareholder because by the increasing of
debt, it affects the distribution of cash to the shareholder to be
decreased but increasing the total value per share.
No shareholders cant do that by It self. It is in the hands of the
firm and the executives
From the problem before, the shareholders pay a premium share
where debt increases the shares value

#6 FROM A MACROECONOMIC POINT OF VIEW, IS SOCIETY BETTER OFF

IF FIRMS USE MORE THAN ZERO DEBT?
Indeed, in light of the fact that it enables banks to loan cash. In the
event that banks don't loan cash, they wind up with
overabundance money which prompts the fall of financing costs
on bank stores. Low financing costs in the long run prompt
expansion which is convey terrible impact to the macroeconomic
condition.
#7