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THE OPTIMAL CAPITAL STRUCTURE (cont’d). THE USE OF LEVERAGE - LBOs

THE OPTIMAL CAPITAL STRUCTURE (cont’d). THE USE OF LEVERAGE - LBOs. Lesson 7. Corporate Finance. Castellanza, 2 nd November, 2011. The choice of the optimal capital structure. Maximization of ROE. Maximization of the enterprise value.

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THE OPTIMAL CAPITAL STRUCTURE (cont’d). THE USE OF LEVERAGE - LBOs

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  1. THE OPTIMAL CAPITAL STRUCTURE (cont’d).THE USE OF LEVERAGE - LBOs Lesson 7 Corporate Finance Castellanza, 2nd November, 2011

  2. The choice of the optimal capital structure Maximization of ROE Maximization of the enterprise value Other key-drivers (balance, flexibility, opportunities, …)

  3. Maximization of shareholders’ return ROE = [ROI + (D/E) (ROI – i)] where: ROE = net profit / equity ROI = Ebit / invested capital (debt + equity) D/E = financial leverage i = cost of debt (interest rate)

  4. Relationship between ROE and ROI Decrease self - financing Decrease ROI Decrease ROE Increase cost of debt Increase debt ROE = [ROI + (D/E) (ROI – i)]

  5. Modigliani-Miller theory Hp: in an environment where there are no taxes, bankruptcy risk or agency costs (no separation between stockholders and managers), capital structure is irrelevant. Ts: the value of a firm (V) is indipendent of its debt ratio (D/E). The cost of capital of the firm will not change with leverage.

  6. Modigliani-Miller theory (cont’d) The effect of taxes V Vl = Vu+ Vats Vu = value of unlevered firm Vl = value od levered firm Vats = actual value of tax shields Vl Vu D/E

  7. Trade-off theory The effect of bankruptcy costs Value of levered firm without bankruptcy costs Vabc Value of levered firm VAts Value of unlevered firm Vl = Vu + Vats - Vabc VAcf actual value of bankruptcy costs

  8. Pecking order theory internal Financing sources external 1. self-financing 2. debt 3. increase of equity

  9. Financing mix decision 1. Macroeconomic context (capital markets) 2. Industry (maturity, capex, risk, etc.) 3. Firm’s characteristics (market position, financial-economic situation, ..) 4. Financial needs’ charact.

  10. Leveraged Buyout deals Definition: A leveraged buyout, or LBO, is the purchase of a company using a large amount of debt -- much of the borrowing secured by the assets of the company itself. Sometimes the target company’s assets are sold to repay the loan that financed the takover Deal: Step 1) NEWCO creation Step 2) NEWCO funding Step 3) Sellers’ payment Step 4) Merger

  11. LBO - Steps Step 1: creation Step 2: funding NEWCO INVESTORS Step 4: merger Step 3: payment TARGET’S SHAREHOLDERS TARGET

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