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Taxes - Constant riskless debt PV of tax shield: Value of levered firm (MM I): Required return to equityholders (MM II): Beta Asset vs Beta Equity Weighted average cost of capital Taxes Debt proportional to value L = D/V PV of tax shield: Value of levered firm (MM I): Required return to equityholders (MM II): Beta Asset vs Beta Equity Weighted average cost of capital
Taxes Variable debt: the Capital Cash Flows Approach (Ruback) Capital cash flow = Free cash flow unlevered + Tax shield Discount rate for capital cash flow = rA
Up uS fu 1 d = = e u
Down dS fd
t
Delta =
fu f d (uS dS )
f =
p=
pfu + (1 p) f d (1 + rf )
1 + rf d
ud (to calculate the true probability, replace rf by the expected return) State price: f = vu fu + vd f d p 1 p vu = vd = 1 + rf 1 + rf Black-Scholes formulas (European option on a stock paying a constant dividend yield q) Call option: C = Se qT N ( d1 ) Ke rT N (d 2 ) d1 = ln( Se qT ) Ke rT + 0.5 T T d2 = ln( Se qT ) Ke rT 0.5 T = d T 1 T
C S N(d2) = risk-neutral probability of exercising the call option Delta (Call ) = e qT N (d1 ) =
D = A DeltaDebt V / D
V = VU + VTS - BC
VTS = [TC C / r ] (1 pB )
BC = pBVB D = (C / r )(1 pB ) + (1 )VB pB
VB = (1 TC )C /( r + 0.5 2 )
pB = (VB / VU ) 2
2r