Is Enterprise Value Independent of Capital Structure?
EV = EQUITY + DEBT - CASH + NCI
Whether your raise more equity or debt it will be offset by the cash raised. (Independent of Capital Structure)
However, I'm looking at this at a perspective of a DCF. When you discount your FCFF by WACC to arrive at your EV. When we change our capital structure, our WACC changes.
For example: our wacc decreases when we take on more debt because it is a cheaper alternative. Won't this lead to a higher enterprise value because our new capital structure?
I suggest you read about Modigliani and Miller theories. Simply there is always a trade-off in when you change your capital structure.
As debt increases risk increases and therefore the Cost of Equity increases, this is at the beginning beneficial to the firm as there is a tax shield that lowers the WACC, but if too much debt its taken, the cost of equity will offset the benefits of the tax shield and therefore the WACC will increase again. So there is an optimal capital structure that gives you an optimal WACC maximising the value of the firm.
Thank you for your response.
I understand that the concept of achieving the target capital structure would maximize firm value, but doesn't this contradict the statement of EV being capital structure neutral? MM theorem only holds when there are no tax benefits, would appreciate your advice and guidance to clarify my misunderstanding.
Well this is only MM 1 without taxes, you'll learn later that there is a second proposition MM 2 and even a third one Miller 1973 I believe. And that all 3 propositions have versions with an without taxes!
Recusandae error commodi et dignissimos. Doloribus veritatis vel veniam cupiditate adipisci et aperiam. Commodi sed consequuntur facere harum. Blanditiis sed repellendus non nobis corporis est alias. Quam asperiores eum sed voluptas eligendi. Dolorum ex omnis laborum dolores.
See All Comments - 100% Free
WSO depends on everyone being able to pitch in when they know something. Unlock with your email and get bonus: 6 financial modeling lessons free ($199 value)
or Unlock with your social account...