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M assumptions hold ? ?? ?? ?? ?? ?EDTE B I TEDDTrEDEETDrE B I TEDDTrEDErW A C Cfffe???????????????1111erHas a change of financial leverage any impact on the firm value ? Answer: Yes ! Discount rate for cash flow of the firm 16 — Stock Price Share Number Total Equity Share Price Company A: 1 million million $ 67 Company B: 600,000 million $ 67 ? If Company A were to announce an issue of $40 million debt to be used to repurchase and retire mon stock A’s capital structure = B’s capital structure Market reaction: price of A’s share would go up to reflect the $ million tax shield: $( + ) million / 1 million = $ per share. Where is the benefit of the tax shield? 17 State Prices 100$?AP107$?AuP98$?AdPu = d = 103$$1$$$Riskfree security %2?frRiskfree interest rate Bond A Bond B ??BP18 — Basic Securities Basic Security 1 Basic Security 2 1$01$0u? d?= ? = ? Portfolio { Basic Security 1, Basic Security 2} AuP AdPreplicating AuPAdPBond A AdAu dPuP ?? ? AP= 1?? du du ??No Arbitrage 19 ? Replicating risk – free security Portfolio { Basic Security 1, Basic Security 2} replicating ? ? ? ?fdfu rr ??? 11 ?? 1= 1$? ? $11$ ??? fr? ? $11$ ??? frLet ff rr ?? 1?????????fdudurdu11????? ?? ?????????durrudurdrffdffu??State Prices P=E[mX] 20 ? Replicating Bond A and Bond B 1 0 0985 4 4 0 74 3 5 ??????? AdAuA dPuPP ?? 4 4 0 34 3 5 ?????BPNo Arbitrage Questions ? 1. Do there exist such kind basic securities in the real world? 2. Are there enough basic securities that can be used to replicate all the payoff of s