Overview
For the purposes of capital structure, the definition of owners of the firm is broadened beyond the shareholders to mean the owneres of the firms cash flows. Alternatively, that means any provider of capital to the firm is an owner in some sense.
Under this definition, the value of a firm is divided between the owners of debt, and the owners of equity. The total value is the sum of these two.
{% Value = Debt + Equity %}
Topics
- Free Cash Flows to the Various owners
- Debt Valuation
{% Debt \, Value = \sum_t \frac{Cash \, Flow \, to \, Debt_t}{(1+r_d)^t} %}Here the rate used to discount the debt cash flows is {% r_d %}, the cost of debt, or the interest rate paid by the debt.
- Equity Valuation
{% Equity \, Value = \sum_t \frac{Cash \, Flow \, to \, Equity_t}{(1+r_e)^t} %}Here the rate used to discount the equity cash flows is {% r_e %}, the cost of equity, or the expected return demanded by equity holders. If the firm fails to earn the cost of equity on average for its shareholders, the price of the firm will decline until the rate of return equals the demanded value.
- Debt Valuation
- Wacc Valuation - weighted average cost of capital valuation, provides a valuation for the firm by creating a weighted average cost of capital from the cost required by each source.