Handbook of Computational Economics, Volume 1 (Handbooks in by H.M. Amman, D.A. Kendrick, J. Rust

By H.M. Amman, D.A. Kendrick, J. Rust

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It is assumed that the risk premium θ changes accordingly to ensure that independence. 2 The Basic ABM-EBIT-Model 45 For V > C/r-firms, risk optimization becomes possible because the firm can trade off 2 effects. By increasing risk, the bankruptcy probability rises thus lowering debt value. However, future tax savings become less valuable and the solvent firm value decreases. The lower the firm value, the less important is the second effect. If a debt covenant is negotiated, equity owners contract on a bankC .

Introduce three different kinds of taxes. Debt holders’ coupon payments are taxed at a tax rate τ d . e. EBIT less coupon payments. Corporate earnings after tax are paid out as a dividend, which is then taxed at the personal tax rate of equity owners τ e . In the last subsection, valuation equations have been stated for all claims of a firm in a solvent state as well as in bankruptcy before taxation. Each of these values can be split further into a value that + − belongs to the investors, E + , E − , as well as DC , DC , and the j ,Tj j ,Tj governments claim G, respectively.

Secondly, the framework is defined quite generally without specifying the functions of the EBIT-drift and volatility explicitly. 11). 7 depends crucially on the EBIT-process assumption and the complexity of the capital structure. Thirdly, all claims are easily interpreted because they are all defined as receiving payments from EBIT. 11). All other valuation formulae remain intact. 3 ABM- and GBM-EBIT-Models If the economic framework of the last chapter is used for pricing corporate securities, a specific assumption about the EBIT-process has to be made.

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