The Cost of Capital, Corporation Finance & The Theory of Investment
The Cost of Capital, Corporation Finance & The Theory of Investment
The Cost of Capital, Corporation Finance & The Theory of Investment
Or, equivalently:
• Now suppose the investor sells the share and acquires instead
s1=α(X- rD2). The new portfolio thus yields:
Note: Key assumption is that investors can borrow at the same rate as firm
Proposition II
Expected
yield of a
share of
stock in firm j
Debt/Equity
Capitalization Ratio
rate p for Spread
pure equity between
stream in p and r
class k
Proof
Simple algebra:
by definition of ij
by Proposition I
Results:
Proposition 1 becomes:
Taxable
income
Proposition 2 becomes: Shareholders’
Average expected net
corporate tax income
rate
Extension II: Plurality of Bonds
• Proposition I remains unaffected
• Proposition II has to be modified
Proof of Case 1
• Recall that and
• Now, let the firm borrow I dollars for an investment
yielding p*. It follows that:
and
and finally