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Ronen_dim
06-02-2004, 04:03 PM
From "Principles of Corporate Finance":
"If you owned a portfolio of all the firms securities - 100 percent of the debt
and 100 percent of the equity - you would own the firm assetes lock, stock and
barrel.
To calculate the company cost of capital just take a weighted average on the expected
return on debt and equity.

Suppose that the firm's market value is as follows:

Asset Value(100)

Debt value(D) 30
Equity value (E) 70
---------------------------------------------------------------
Firm Value (100)

Note that the values of the debt and equity add up to the firm value ( D + E = V) and the firms
equals the asset value."

My question are:
How can company debt be considered part of the the company value?
For example If I open a company and borrow \$100,000, will my company
worth \$100,000 ?
How can you expect a return on debt?
What does he mean by owning equity - owning all the shares of the company?
What return does he expects to get on the equity - a gain from shares prices?

Thanks for any help,
Ron

Westley
06-02-2004, 04:55 PM
If you start a company and borrow \$100k, and use that to buy \$100k worth of office supplies, then that company will have \$100k of assets. If you then issue equities for \$100k and buy a \$100k office, you will have company assets of \$100k. That's a company with \$100k D, \$100k E, and firm value or asset value of \$200k.

Westley
06-02-2004, 04:57 PM
How can I expect a return on debt?

If I loan you \$100k to bbuy those office supplies, and I require you to pay back \$110k in a year, then the return on that debt is 10%.

Westley
06-02-2004, 04:57 PM

wonderer
06-03-2004, 10:43 AM
Just because your firm is worth 200k doesn't mean your firm is entitled to keep the cash flow generated.

bm1729
06-03-2004, 11:32 AM
How can I expect a return on debt?

If I loan you \$100k to buy those office supplies, and I require you to pay back \$110k in a year, then the return on that debt is 10%.
I think Ronen meant "how can the firm (i.e., borrower) expect a return on its debt?" He was looking at it from the firm's perspective. The answer, of course, is that firms do not earn a return on their debt, but they do earn a return on the money raised by issuing that debt. (I use the term "issuing" because I am thinking along the lines of a bond issue, which is only one of several forms of debt.) However, I think "return on debt" refers to the return earned by the holders of that debt (e.g., bondholders).

[I keep editing this freakin' post. I'll eventually get it right.]

2+2=5
06-03-2004, 11:33 AM
Just a suggestion:
You're might have more luck if you post this in the Course 2 forum since this is Course 2 material.

statzman
06-05-2004, 08:09 PM
Let's say you put of \$70 of your own money - You own all the equity (ownership) of the company.

You need a total of \$100 to buy the machinery (assets) to get the company going, so you borrow \$30. This is the debt.

Let's say you are paying 5% interest on the debt.

And that you personally would like to make 12% a year on your investment.

Then the cost of capital to the company - the amount that is required - is:
0.3 * 5% + 0.7 * 12% = 9.9%

So, if the company is able to make in income 9.9% a year of the \$100 (so this is \$9.90) that will be enough to pay of the debt, and get the 12% a year return you want. Specifically, you will pay \$1.50 to the bondholders (\$30 * 5%) and you keep \$8.40 for yourself (\$70 * 12%).