Peter Brusov, Tatiana Filatova, Natali Orekhova, Mukhadin Eskindarov Auth. Modern Corporate Finance, Investments and Taxation

PeterBrusov TatianaFilatova
NataliOrekhova MukhadinEskindarov
Modern
Corporate
Finance,
Investments
and Taxation
Modern Corporate Finance, Investments and
Taxation
ThiS is a FM Blank Page
Peter Brusov Tatiana Filatova
Natali Orekhova Mukhadin Eskindarov
Modern Corporate Finance,

Investments and Taxation
Peter Brusov Tatiana Filatova
Financial University under the Financial University under the Government
Government of Russian Federation of Russian Federation
Moscow Moscow
Russia Russia
Natali Orekhova Mukhadin Eskindarov

High School of Business Financial University under the Government
Southern Federal University of Russian Federation
Rostov-on-Don Moscow
Russia Russia
Corporate Finance, Investment and
Taxation Laboratory
Research Consortium of Universities
of the South of Russia
Rostov-on-Don
Russia
ISBN 978-3-319-14731-4 ISBN 978-3-319-14732-1 (eBook)

DOI 10.1007/978-3-319-14732-1
Library of Congress Control Number: 2015938761
Springer Cham Heidelberg New York Dordrecht London

Springer International Publishing Switzerland 2015
This work is subject to copyright. All rights are reserved by the Publisher, whether the whole or part of
the material is concerned, specifically the rights of translation, reprinting, reuse of illustrations,
recitation, broadcasting, reproduction on microfilms or in any other physical way, and transmission
or information storage and retrieval, electronic adaptation, computer software, or by similar or
dissimilar methodology now known or hereafter developed.
The use of general descriptive names, registered names, trademarks, service marks, etc. in this
publication does not imply, even in the absence of a specific statement, that such names are exempt
from the relevant protective laws and regulations and therefore free for general use.
The publisher, the authors and the editors are safe to assume that the advice and information in this
book are believed to be true and accurate at the date of publication. Neither the publisher nor the
authors or the editors give a warranty, express or implied, with respect to the material contained
herein or for any errors or omissions that may have been made.
Printed on acid-free paper
Springer International Publishing AG Switzerland is part of Springer Science+Business Media

(www.springer.com)
Dedicated to our dear granddaughter Anyuta,
who sings songs equally wonderful in Russian
and in German
Preface
This book describes in detail the modern theory of corporate finance, investment,
and taxation, created by Brusov, Filatova, and Orekhova (BFO theory), which has
replaced the famous theory of capital cost and capital structure by Nobel laureates
Modigliani and Miller. The authors have moved from the assumption of
ModiglianiMiller concerning the perpetuity (infinite time of life) of companies
and further elaborated quantitative theory of valuation of key parameters of finan-
cial activities of companies with arbitrary time of life (of arbitrary age).
Results of modern BFO theory turn out to be quite different from those of
ModiglianiMiller theory. They show that the latter, via its perpetuity, underesti-
mates the assessment of weighted average cost of capital, WACC, and the equity
cost of the company and substantially overestimates the assessment of the capital-
ization of the company.
Such an incorrect assessment of key performance indicators of financial activ-
ities of companies has led to an underestimation of risks involved, and impossibil-
ity, or serious difficulties in adequate managerial decision-making, which was one
of the implicit reasons of global financial crisis in 2008.
Within new modern theory of capital cost and capital structure (BFO theory), a
lot of qualitatively new results have been obtained, among them:
1. The qualitatively new effect in corporate finance, discovered by authors: abnor-
mal dependence of equity cost on leverage, which alters the main principles of
the companys dividend policy significantly.
2. Bankruptcy of the famous trade-off theory has been proven.
3. A very important discovery has been done recently: the valuation of WACC in
the ModiglianiMiller theory (perpetuity limit) is not minimal and valuation of
the company capitalization is not maximal, as all financiers supposed up to now:
at some age of the company (golden age) its WACC value turns out to be
lower than in perpetuity limit and company capitalization V turns out to be
greater than perpetuity limit of V.
vii
viii Preface
4. Mechanism of formation of the company optimal capital structure, different

from the one suggested by trade-off theory, has been suggested.
5. The inflation in both ModiglianiMiller as well as in BrusovFilatova
Orekhova theories has been taken into account in explicit form, which has a
nontrivial impact on the dependence of equity cost on leverage.
6. Study of the role of taxes and leverage has been done, which allows the
Regulator to set up the tax on profits rate and allows businessmen to choose
the optimal level of debt financing.
7. Investigation of the influence of tax on profit rate on the effectiveness of
investment projects at different debt levels has showed that increase of tax on
profit rate from one side leads to decrease of project NPV, but from other side it
leads to decrease of sensitivity of NPV with respect to leverage level. At high
leverage level L, the influence of tax on profit rate change on effectiveness of
investment projects becomes significantly less.
8. Studying the influence of growth of tax on profit rate on the efficiency of the
investment as well has led to two qualitatively new effects in investments:
the growth of tax on profit rate changes the nature of the NPV dependence on
leverage L: at some value t*, there is a transition from diminishing function
NPV(L ) at t < t*, to growing function NPV(L ) at t > t*.
at high leverage levels, the growth of tax on profit rate leads to the growth of
the efficiency of the investments.
Discovered effects in investments can be applied in a real economic practice for
optimizing of the management of investments.
Established BFO theory allows us conduct a valid assessment of the core
parameters of financial activities of companies, such as weighted average cost of
capital, equity capital cost of the company, and companys capitalization. It allows
the management of a company to make adequate decisions, which improves the
effectiveness of the company management. More generally, the introduction of the
new system of evaluation of the core parameters of financial activities of companies
into the systems of financial reporting (IFRS, GAAP, etc.) would lead to a lower
risk of global financial crisis.
The second part of this book is devoted to the assessment of effectiveness of
investment projects created by the authors within the modern investment models.
The determination of the optimal leverage level for investments is studied in this
book from two points of view: from the point of view of owners of equity capital, as
well as from the point of view of owners of both equity and debt capital.
Corporate management in the modern world is the management of financial
flows. The proposed BrusovFilatovaOrekhova theory allows to correctly identify
discount ratesbasic parameters for discounting of financial flows to arbitrary
time moment, compare financial flows with a view to adopt literate managerial
decisions. The discount rate is a key link to the existing financial system, on which
the modern finance can be adequately built, and this proposed book can be of
substantial assistance.
Preface ix
This book is intended for students, postgraduate students, teachers of economic

and financial institutions, students of MBA program, scientists, financial analysts,
financial directors of company, managers of insurance companies and rating agen-
cies, officials of regional and federal ministries and departments, and ministers
responsible for economic and financial management.
49 Leningradsky Ave. Peter Brusov

Moscow
Russia, 125993, GSP-3
4 February 2014
Contents
Part I Corporate Finance

1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6
2 Capital Structure: ModiglianiMiller Theory . . . . . . . . . . . . . . . . . 9
2.1 The Traditional Approach . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
2.2 ModiglianiMiller Theory . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
2.2.1 ModiglianiMiller Theory Without Taxes . . . . . . . . . . 10
2.2.2 ModiglianiMiller Theory with Taxes . . . . . . . . . . . . . 12
2.2.3 Main Assumptions of ModiglianiMiller Theory . . . . . 15
2.2.4 Modifications of ModiglianiMiller theory . . . . . . . . . 16
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25
3 Modern Theory of Capital Cost and Capital Structure:
BrusovFilatovaOrekhova Theory (BFO Theory) . . . . . . . . . . . . . 27
3.1 Companies with Arbitrary Lifetime (Arbitrary Age):
BrusovFilatovaOrekhova Equation . . . . . . . . . . . . . . . . . . . . 28
3.2 Comparison of ModiglianiMiller Results (Perpetuity Company)
with Myers Results (1-Year Company) and BrusovFilatova
Orekhova Ones (Company with Arbitrary Lifetime
(Arbitrary Age)) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30
3.3 BrusovFilatovaOrekhova Theorem . . . . . . . . . . . . . . . . . . . . 32
3.4 From ModiglianiMiller to General Theory of Capital Cost
and Capital Structure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 37
3.5 BFO Theory in the Case, When the Company Ceased to Exist
at the Time Moment n . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 39
3.5.1 Application of Formula BFO-2 . . . . . . . . . . . . . . . . . . 41
3.5.2 Comparison of Results Obtained from Formulas
BFO and BFO-2 . . . . . . . . . . . . . . . . . . . . . . . . . . . . 42
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45
xi
xii Contents
4 Bankruptcy of the Famous Trade-Off Theory . . . . . . . . . . . . . . . . 47

4.1 Optimal Capital Structure of the Company . . . . . . . . . . . . . . . . 47
4.2 Absence of the Optimal Capital Structure in Modified
ModiglianiMiller Theory (MMM Theory) . . . . . . . . . . . . . . . 50
4.3 Analysis of the Trade-Off Theory Within the BrusovFilatova
Orekhova Theory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 51
4.4 The Causes of Absence of the Optimum Capital Structure in
Trade-Off Theory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 61
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 71
5 New Mechanism of Formation of the Companys Optimal Capital
Structure, Different from Suggested by Trade-Off Theory . . . . . . . 73
5.1 Absence of Suggested Mechanism of Formation of the
Companys Optimal Capital Structure Within Modified
ModiglianiMiller Theory (MMM Theory) . . . . . . . . . . . . . . . 73
5.2 Formation of the Companys Optimal Capital Structure Within
BrusovFilatovaOrekhova (BFO) Theory . . . . . . . . . . . . . . . . 75
5.3 Simple Model of Proposed Mechanism . . . . . . . . . . . . . . . . . . 88
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 91
6 The Global Causes of the Global Financial Crisis . . . . . . . . . . . . . . 93
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 98
7 The Role of Taxing and Leverage in Evaluation of Capital Cost
and Capitalization of the Company . . . . . . . . . . . . . . . . . . . . . . . . . 99
7.1 The Role of Taxes in ModiglianiMiller Theory . . . . . . . . . . . . 100
7.2 The Role of Taxes in BrusovFilatovaOrekhova Theory . . . . . 102
7.2.1 Weighted Average Cost of Capital
of the Company WACC . . . . . . . . . . . . . . . . . . . . . . . 103
7.2.2 Equity Cost ke of the Company . . . . . . . . . . . . . . . . . . 105
7.2.3 Dependence of WACC and ke on Lifetime (Age)
of Company . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 107
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 113
8 A Qualitatively New Effect in Corporate Finance: Abnormal
Dependence of Equity Cost of Company on Leverage . . . . . . . . . . . 115
8.1 Equity Cost in the ModiglianiMiller Theory . . . . . . . . . . . . . . 116
8.2 Equity Cost Capital Within BrusovFilatovaOrekhova
Theory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 118
8.2.1 Dependence of Equity Cost ke on Tax on Profit Rate
T at Different Fixed Leverage Level L . . . . . . . . . . . . 120
8.2.2 Dependence of Equity Cost ke on Leverage Level
L (the Share of Debt Capital wd) at Different Fixed
Tax on Profit Rate T . . . . . . . . . . . . . . . . . . . . . . . . . . 121
8.3 Dependence of the Critical Value of Tax on Profit Rate T *
on Parameters n, k0, kd of the Company . . . . . . . . . . . . . . . . . . 124
Contents xiii
8.4 Practical Value of Effect . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 128

8.5 Equity Cost of 1-Year Company . . . . . . . . . . . . . . . . . . . . . . . 129
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 132
9 Inflation in BrusovFilatovaOrekhova Theory and in Its Perpetuity
LimitModiglianiMiller Theory . . . . . . . . . . . . . . . . . . . . . . . . . 135
9.1 Accounting of Inflation in ModiglianiMiller Theory
Without Taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 136
9.2 Accounting of Inflation in ModiglianiMiller Theory with
Corporate Taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 140
9.3 Accounting of Inflation in BrusovFilatovaOrekhova Theory
with Corporate Taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 142
9.3.1 Generalized BrusovFilatovaOrekhova Theorem . . . . 142
9.4 Generalized BrusovFilatovaOrekhova Formula Under
Existence of Inflation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 143
9.5 Irregular Inflation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 151
9.6 Inflation Rate for a Few Periods . . . . . . . . . . . . . . . . . . . . . . . 151
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 153
Part II Investments
10 A Portfolio of Two Securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 157
10.1 A Portfolio of Two Securities . . . . . . . . . . . . . . . . . . . . . . . . . 157
10.1.1 A Case of Complete Correlation . . . . . . . . . . . . . . . . . 157
10.1.2 Case of Complete Anticorrelation . . . . . . . . . . . . . . . . 159
10.1.3 Independent Securities . . . . . . . . . . . . . . . . . . . . . . . . 160
10.1.4 Three Independent Securities . . . . . . . . . . . . . . . . . . . 162
10.2 Risk-free Security . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 165
10.3 Portfolio of a Given Yield (Or Given Risk) . . . . . . . . . . . . . . . 167
10.3.1 Case of Complete Correlation (12 1) and Complete
Anticorrelation (12 1) . . . . . . . . . . . . . . . . . . . . . 168
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 169
11 Investment Models with Debt Repayment at the End of the Project
and Their Application . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 171
11.1 Investment Models . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 171
11.2 The Effectiveness of the Investment Project from
the Perspective of the Equity Holders Only . . . . . . . . . . . . . . . 172
11.2.1 With the Division of Credit and Investment Flows . . . . 172
11.3 Without Flows Separation . . . . . . . . . . . . . . . . . . . . . . . . . . . . 174
11.4 ModiglianiMiller Limit (Perpetuity Projects) . . . . . . . . . . . . . 175
11.4.1 With Flows Separation . . . . . . . . . . . . . . . . . . . . . . . . 175
11.4.2 Without Flows Separation . . . . . . . . . . . . . . . . . . . . . 176
the Perspective of the Owners of Equity and Debt . . . . . . . . . . 177
xiv Contents
11.6 ModiglianiMiller Limit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 179

References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 181
12 Influence of Debt Financing on the Efficiency of Investment Projects:
The Analysis of Efficiency of Investment Projects Within
the Perpetuity (ModiglianiMiller) Approximation . . . . . . . . . . . . 183
the Perspective of the Equity and Debt Owners . . . . . . . . . . . . 200
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 216
13 The Analysis of the Exploration of Efficiency of Investment
Projects of Arbitrary Duration (Within BrusovFilatova
Orekhova Theory) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 217
13.1.2 Without Flow Separation . . . . . . . . . . . . . . . . . . . . . . 225
13.2.2 Without Flow Separation . . . . . . . . . . . . . . . . . . . . . . 242
13.3 The Elaboration of Recommendations on the Capital Structure
of Investment of Enterprises, Companies, Taking into Account
All the Key Financial Parameters of Investment Project . . . . . . 250
13.3.1 General Conclusions and Recommendations
on the Definition of Capital Structure of Investment
of Enterprises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 250
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 252
14 Investment Models with Uniform Debt Repayment and Their
Application . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 253
14.1 Investment Models with Uniform Debt Repayment . . . . . . . . . . 253
14.2 The Effectiveness of the Investment Project from the Perspective
of the Equity Holders Only . . . . . . . . . . . . . . . . . . . . . . . . . . . 255
Contents xv

14.4 Example of the Application of the Derived Formulas . . . . . . . . 258
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 259
15 Is It Possible to Increase Taxing and Conserve a Good Investment
Climate in the Country? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 261
15.1 Influence of Tax on Profit Rates on the Efficiency
of the Investment Projects . . . . . . . . . . . . . . . . . . . . . . . . . . . . 261
15.2 Investment Models . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 263
15.3 Borrowings Abroad . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 265
15.4 Dependence of NPV on Tax on Profit Rate at Different
Leverage Levels . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 267
15.5 At a Constant Value of Equity Capital (S Const) . . . . . . . . . . 268
15.6 Without Flow Separation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 270
15.6.1 At a Constant Value of the Total Invested Capital
(I Const) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 270
15.6.2 At a Constant Value of Equity Capital (S Const) . . . . 272
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 274
16 Is It Possible to Increase the Investment Efficiency by Increasing
Tax on Profit Rate? An Abnormal Influence of the Growth
of Tax on Profit Rate on the Efficiency of the Investment . . . . . . . . 277
16.1 Dependence of NPV on Leverage Level L at Fixed Levels
of Tax on Profit Rate t . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 277
16.1.1 The Effectiveness of the Investment Project from
the Perspective of the Equity Holders Only . . . . . . . . . 277
the Perspective of the Equity and Debt Holders . . . . . . 288
16.2 Dependence of NPV on Tax on Profit Rate at Fixed Leverage
Levels L . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 294
the Perspective of the Equity Holders Only . . . . . . . . . 294
the Perspective of the Equity and Debt Holders . . . . . . 301
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 308
17 Optimizing the Investment Structure of the Telecommunication
Sector Company . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 309
17.1 Investment Analysis and Recommendations
for Telecommunication Company Nastcom Plus . . . . . . . . . . 310
17.1.1 The Dependence of NPV on Investment Capital
Structure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 311
17.1.2 The Dependence of NPV on the Equity Capital Value
and Coefficient . . . . . . . . . . . . . . . . . . . . . . . . . . . . 320
xvi Contents
17.2 Effects of Taxation on the Optimal Capital Structure

of Companies in the Telecommunication Sector . . . . . . . . . . . . 326
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 338
18 The Golden Age of the Company (Three Colors of Companys
Time) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 339
18.1 Dependence of WACC on the Lifetime (Age) of the Company
n at Different Leverage Levels . . . . . . . . . . . . . . . . . . . . . . . . 343
n at Different Values of Capital Costs (Equity, k0, and Debt, kd)
and Fixed Leverage Levels . . . . . . . . . . . . . . . . . . . . . . . . . . . 345
n at Different Values of Debt Capital Cost, kd, and Fixed
Equity Cost, k0, and Fixed Leverage Levels . . . . . . . . . . . . . . . 348
n at Different Values of Equity Cost, k0, and Fixed Debt
Capital Cost, kd, and Fixed Leverage Levels . . . . . . . . . . . . . . . 352
n at High Values of Capital Cost (Equity, k0, and Debt, kd)
and High Lifetime of the Company . . . . . . . . . . . . . . . . . . . . . 355
18.6 Further Investigation of Effect . . . . . . . . . . . . . . . . . . . . . . . . . 361
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 364
19 Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 367
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 368
Part I
Corporate Finance
Chapter 1
Introduction
One of the main problems in corporate finance is the problem of cost of capital and
the impact of capital structure on its cost and capitalization of the companies. To
date, even the question of the existence of an optimal capital structure of the
companies (at which the company capitalization is maximal, and weighted average
cost of capital is minimal) is open. Numerous theories and models, including the
first and the only one until recently quantitative theory by Nobel laureates Modi-
gliani and Miller (MM) (Modigliani et al. 1958, 1963, 1966), not only does not
solve the problem but also because of the large number of restrictions (such as, for
example, theory of MM) have a weak relationship with the real economy. Herewith
the qualitative theories and models, based on the empirical approach, do not allow
to carry out the necessary assessment.
In the monograph, the foundation of modern corporate finance, investment, and
taxation is laid. It is based on the authors work on modifying theory of capital cost
and capital structure by Nobel Prize winners Modigliani and Miller, which led to
the actual replacement of this theory by the modern theory by BrusovFilatova
Orekhova (BFO theory) (Brusov and Filatova 2011; Brusov et al. 2011a, b, c,
2012a, b, 2013a, b, 2014a, b; Filatova et al. 2008, Brusova 2011). The authors have
moved from the assumption of ModiglianiMiller concerning the perpetuity (infi-
nite time of life or infinite age) of companies and further elaborated quantitative
theory of valuation of core parameters of financial activities of companies with
arbitrary time of life (of arbitrary age).
Results of modern BFO theory (Brusov and Filatova 2011; Brusov et al. 2011a,
b, c, 2012a, b, 2013a, b, 2014a, b; Filatova et al. 2008; Brusova 2011) turn out to
be quite different from that of ModiglianiMiller theory (Modigliani et al. 1958,
1963, 1966). They show that later, via its perpetuity, underestimates (often signif-
icantly) the assessment of weighted average cost of capital and the equity cost of the
company and substantially overestimates (also often significantly) the assessment
of the capitalization of both financially independent company as well as the
company using the debt financing.
Springer International Publishing Switzerland 2015 3

P. Brusov et al., Modern Corporate Finance, Investments and Taxation,
DOI 10.1007/978-3-319-14732-1_1
4 1 Introduction
Such an incorrect assessment of key performance indicators of financial activ-

ities of companies has led to an underestimation of risks involved, and impossibil-
ity, or serious difficulties in adequate managerial decision-making, which was one
of the implicit reasons of global financial crisis of the year 2008.
Within new theory of capital cost and capital structure (BFO theory), a study of
the role of taxes and leverage has been done, which allows the regulator to set the
tax on profit rate and businesses to choose the optimal level of debt financing. The
qualitatively new effect in corporate finance, discovered by authors, is described:
abnormal dependence of equity cost on leverage, which significantly alters the
principles of development of the companys dividend policy (modern principles of
which are formulated in monograph). Authors take into account in explicit form the
inflation in both ModiglianiMiller as well as BrusovFilatovaOrekhova theories,
with which they detected its nontrivial impact on the dependence of equity cost on
leverage.
The established BFO theory (Brusov and Filatova 2011; Brusov et al. 2011a, b,
c, 2012a, b, 2013a, b, 2014a, b; Filatova et al. 2008) allows conduct a valid
assessment of the core parameters of financial activities of companies, such as
weighted average cost of capital and equity capital cost of the company, its
capitalization. It allows the management of a company to make adequate decisions,
which improves the effectiveness of the company management. More generally, the
introduction of the new system of evaluation of the parameters of financial activ-
ities of companies into the systems of financial reporting (IFRS, GAAP, etc.) would
lead to lower risk of global financial crisis, since, as is shown in the monograph, a
primary cause of the crisis of 2008 was a mortgage crisis in the USA, which is
associated with overvalued capitalization of mortgage companies by rating agen-
cies, using incorrect MM theory. This reason is now understood by the US Gov-
ernment, which requires $1 billion from rating agency S&P for overvalued
capitalization of mortgage companies.
Within BrusovFilatovaOrekhova theory, the analysis of wide-known trade-off
theory has been made (Brusov et al. 2013a). It is shown that suggestion of risky debt
financing (and growing credit rate near the bankruptcy) in opposite to waiting result
does not lead to growth of weighted average cost of capital, WACC, which still
decreases with leverage. This means the absence of minimum in the dependence of
WACC on leverage as well as the absence of maximum in the dependence of
company capitalization on leverage. This means that the optimal capital structure is
absent in famous trade-off theory, and this fact proves the insolvency of famous
trade-off theory.
Under condition, proved by authors, of insolvency of well-known classical
trade-off theory, the question of finding a new mechanism of the formation of the
companys optimal capital structure, different from one suggested by trade-off
theory, becomes very important. A new such mechanism has been developed by
the authors in this monograph. It is based on the decrease of debt cost with leverage,
which is determined by growth of debt volume. This mechanism is absent in
perpetuity ModiglianiMiller theory (Modigliani et al. 1958, 1963, 1966), even in
modified version, developed by us, and exists within more general BFO theory.
1 Introduction 5
The second part of this monograph is devoted to assess effectiveness of the

investment projects (IP). The authors created the modern investment models of
evaluation of the efficiency of IP index, using as a discount rate, the correct values
of weighted average cost of capital as well as the equity cost of the company,
obtained in the BFO theory and in its perpetuity limit (MM theory).
Since virtually every investment project uses debt financing, one of the most
important problems is the determination of the optimal leverage level for invest-
ments. The monograph studies this problem from two points of view: from the point
of view of owners of equity capital, as well as from the point of view of owners of
both equity and debt capital. The study has being conducted without division of
cash flows as well as with division of cash flows on the financial and operating plus
investment flows (Brusov et al. 2011c, 2012a).
Within the framework of the established models, the evaluation of the effective-
ness of investment from the point of view of their optimal capital structure has been
made on the example of one of the largest telecommunication companies in Russia.
It has been shown that there is an optimum structure of investment capital. But
company has lost from $98 million up to $645 million because the company has
worked at leverage levels, which were far from optimal values. The procedure
proposed by authors for evaluation of the efficiency of investment projects will
avoid such losses in the future.
In this monograph, the significant attention has been given to the study of taxes
and taxation in manufacture as well as in investments. Some recommendations for
regulator concerning taxation (value of tax on profit rates, etc.) have been done.
Investigation of the influence of tax on profit rate on effectiveness of investment
projects at different debt levels showed that increase of tax on profit rate from one
side leads to decrease of project NPV, but from other side, it leads to decrease of
sensitivity of NPV with respect to leverage level. At high leverage level L, the
influence of changes of tax on profit rate on effectiveness of investment projects
becomes significantly less.
Studying the influence of growth of tax on profit rate on the efficiency of the
investment as well has led to two qualitatively new effects in investments:
1. The growth of tax on profit rate changes the nature of the NPV dependence on
leverage at some value t*: there is a transition from diminishing function NPV
(L ) when t<t* to growing function NPV(L ).
2. At high leverage levels, the growth of tax on profit rate leads to the growth of the
efficiency of the investments.
Discovered effects in investments can be applied in a real economic practice for
optimizing the management of investments.
A very important discovery has been done recently by the authors within BFO
theory. It is shown for the first time that valuation of WACC in the Modigliani
Miller theory (perpetuity limit) (Modigliani et al. 1958, 1963, 1966) is not minimal,
and valuation of the company capitalization is not maximal, as all financiers
6 1 Introduction
supposed up to now: at some age of the company (golden age), its WACC value
turns out to be lower, than in ModiglianiMiller theory and company capitalization
V turns out to be greater, than V in ModiglianiMiller theory (see Chap. 18).
A distinctive feature of the book is the extensive and adequate use of mathe-
matics that allows the reader to count various financial and economic parameters,
including investment and taxation ones, up to the quantitative result.
Corporate management in the modern world is the management of financial
flows. The proposed BrusovFilatovaOrekhova theory (Brusov and Filatova 2011;
Brusov et al. 2011a, b, c, 2012a, b, 2013a, b, 2014a, b; Filatova et al. 2008) allows
the reader to correctly identify discount ratesbasic parameters for discounting
financial flows to arbitrary time momentand to compare financial flows with a
view to adopt literate managerial decisions. The discount rate is a key link of the
existing financial system, by pulling on which modern finance can be adequately
built, and the proposed monograph can be of substantial assistance in this.
This monograph is intended for students, postgraduate students, teachers of
economic and financial institutions, students of MBA program, scientists, financial
analysts, financial directors of company, managers of insurance companies and
rating agencies, officials of regional and federal ministries and departments, and
ministers responsible for economic and financial management.
References
Brusov PN, Filatova V (2011) From ModiglianiMiller to general theory of capital cost and
capital structure of the company. Finance Credit 435:28
Brusov P, Filatova T, Orehova N, Brusova A (2011a) Weighted average cost of capital in the
theory of ModiglianiMiller, modified for a finite lifetime company. Appl Financ Econ 21
(11):815824
Brusov P, Filatova T, Orehova N et al (2011b) From ModiglianiMiller to general theory of capital
cost and capital structure of the company. Res J Econ Bus ICT 2:1621
Brusov P, Filatova T, Orehova N et al (2011c) Influence of debt financing on the effectiveness of
the investment project within the ModiglianiMiller theory. Res J Econ Bus ICT (UK) 2:1115
Brusov P, Filatova T, Eskindarov M, Orehova N (2012a) Influence of debt financing on the
effectiveness of the finite duration investment project. Appl Financ Econ 22(13):10431052
Brusov P, Filatova T, Eskindarov M, Orehova N (2012b) Hidden global causes of the global
financial crisis. J Rev Global Econ 1:106111
Brusov P, Filatova P, Orekhova N (2013a) Absence of an optimal capital structure in the famous
tradeoff theory! J Rev Global Econ 2:94116
Brusov P, Filatova T, Orehova N (2013b) A qualitatively new effect in corporative finance:
abnormal dependence of cost of equity of company on leverage. J Rev Global Econ 2:183193
Brusov P, Filatova P, Orekhova N (2014a) Mechanism of formation of the company optimal
capital structure, different from suggested by trade off theory. Cogent Econ Finance 2:113.
http://dx.doi.org/10.1080/23322039.2014.946150
Brusov P, Filatova T, Orehova N (2014b) Inflation in BrusovFilatovaOrekhova theory and in its
perpetuity limitModiglianiMiller theory. J Rev Global Econ 3:175185
References 7
Brusova A (2011) comparison of the three methods of estimation of weighted average cost of
capital and equity cost of company. Financ Anal Prob Sol 34(76):3642
Filatova , Orehova N, Brusova (2008) Weighted average cost of capital in the theory of
ModiglianiMiller, modified for a finite life-time company. Bull FU 48:6877
odigliani F, iller M (1958) The cost of capital, corporate finance, and the theory of investment.
Am Econ Rev 48:261297
odigliani F, iller M (1963) Corporate income taxes and the cost of capital: a correction. Am
Econ Rev 53:147175
Modigliani F, Miller M (1966) Some estimates of the cost of capital to the electric utility industry
19541957. Am Econ Rev 56:333391
Chapter 2
Capital Structure: ModiglianiMiller Theory
Under the capital structure, one understands the relationship between equity and
debt capital of the company. Does capital structure affect the companys main
settings, such as the cost of capital, profit, value of the company, and the others,
and, if affects, how? Choice of an optimal capital structure, i.e., a capital structure,
which minimizes the weighted average cost of capital, WACC, and maximizes the
value of the company, V, is one of the most important tasks solved by financial
manager and by the management of a company. The first serious study (and first
quantitative study) of influence of capital structure of the company on its indicators
of activities was the work by Modigliani and Miller (1958). Until this study, the
approach existed (let us call it traditional), which was based on empirical data
analysis.
2.1 The Traditional Approach
The traditional (empirical) approach told that weighted average cost of capital,
WACC, and the associated company capitalization, V CF=WACC, depend on the
capital structure, the level of leverage, L. Debt cost always turns out to be lower
than equity cost because first one has lower risk, via the fact, that in the event of
bankruptcy creditor claims are met prior to shareholders claims.
As a result, an increase in the proportion of lower-cost debt capital in the overall
capital structure up to the limit which does not cause violation of financial sustain-
ability and growth of risk of bankruptcy leads to lower weighted average cost of
capital, WACC.
The profitability required by investors (the equity cost) is growing; however, its
growth has not led to compensation of benefits from use of lower-cost debt capital.
Therefore, the traditional approach welcomes the increased leverage L D=S and
the associated increase of company capitalization. The traditional (empirical)

DOI 10.1007/978-3-319-14732-1_2
10 2 Capital Structure: ModiglianiMiller Theory
approach has existed up to appearance of the first quantitative theory by Modigliani

and Miller (1958).
2.2 ModiglianiMiller Theory
2.2.1 ModiglianiMiller Theory Without Taxes
Modigliani and Miller () in their first paper (odigliani and iller 1958) have
come to the conclusions which were fundamentally different from the conclusions
of traditional approach. Under assumptions (see Sect. 2.2.3 for details) that there are
no taxes, no transaction costs, no bankruptcy costs, perfect financial markets exist
with symmetry information, equivalence in borrowing costs for both companies and
investors, etc., they have showed that choosing of the ratio between the debt and
equity capital does not affect company value as well as capital costs (Fig. 2.1).
Under above assumptions, Modigliani and Miller have analyzed the impact of
financial leverage, supposing the absence of any taxes (on corporate profit as well as
individual one). They have formulated and proven two following statements.
Without taxes, the total cost of any company is determined by the value of its
EBITEarnings Before Interest and Taxes, discounted with fixed rate k0,
corresponding to group of business risk of this company:
Fig. 2.1 Dependence of

company capitalization, UL,
equity cost, ke, debt cost, kd,
and weighted average cost
of capital, WACC, in
traditional (empirical)
approach
2.2 ModiglianiMiller Theory 11
EBIT
VL VU : 2:1
k0
Index L means financially dependent company (using debt financing), while

index U means a financially independent company.
Authors supposed that both companies belong to the same group of business risk,
and k0 corresponds to required profitability of financially independent company,
having the same business risk.
Because, as it follows from the formula (Eq. 2.1), value of the company does not
depend on the value of debt, than according to ModiglianiMiller theorem
(odigliani and iller 1958), in the absence of taxes, value of the company is
independent of the method of its funding. This means as well that weighted average
cost of capital, WA, of this company does not depend on its capital structure and
is equal to the capital cost, which this company will have under the funding by
equity capital only.
V0 VL; CF=k0 CF=WACC, and thus WACC k0 :
Note that first ModiglianiMiller theorem is based on suggestion about indepen-

dence of weighted average cost of capital and debt cost on leverage level.
From the first ModiglianiMiller theorem (odigliani and iller 1958), it is
easy to derive an expression for the equity capital cost
WACC k0 ke we kd wd : 2:2
Finding from here ke, one gets
k0 wd k0 S D D D
ke kd kd k0 k0 kd k0 k0 kd L 2:3
we we S S S
Here,
D value of debt capital of the company
S value of equity capital of the company
kd , wd DS
D cost and fraction of debt capital of the company
ke , we DS
S cost and fraction of equity capital of the company
L D=S financial leverage
Thus, we come to second statement (theorem) of ModiglianiMiller theory

about the equity cost of financially dependent (leverage) company (odigliani
and iller 1958).
Equity cost of leverage company ke could be found as equity cost of finan-
cially independent company k0 of the same group of risk, plus premium for
risk, the value which is equal to production of difference k0 kd on leverage
level L:
ke k0 k0 kd L: 2:4
Formula (Eq. 2.4) shows that equity cost of the company increases linearly with
leverage level (Fig. 2.1).
The combination of these two ModiglianiMiller statements implies that the
increasing of level of debt in the capital structure of the company does not lead to
increased value of firms, because the benefits gained from the use of more low-cost
debt capital markets will be exactly offset by an increase in risk (we are speaking
about the financial risk, the risk of bankruptcy) and, therefore, by an increase in cost
of equity capital of firms: investors will increase the required level of profitability
under increased risk, by which a higher level of debt in the capital structure is
accompanied.
In this way, the ModiglianiMiller theorem argues that in the absence of the
taxes, the capital structure of the company does not affect the value of the company
and its weighted average cost of capital, WACC, and equity cost increases linearly
with the increase of financial leverage.
Explanations, given by Modigliani and Miller under receiving of their conclu-
sions, are the following (odigliani and iller 1958). Value of the company
depends on profitability and risk only and does not depend on the capital structure.
Based on the principle of preservation of the value, they postulated that the value of
the company, which is equal to the sum of the equity and debt funds, is not changed
when the ratio between its parts is changed. An important role in justification of
ModiglianiMiller statements an existence of an arbitral awards opportunities for
the committed markets plays. Two identical companies, differing only by the
leverage level, must have the same value. If this is not the case, the arbitration
aligns business cost: investors of less cost company can invest capital in a company
of more value. Selling of shares of the first company and buying of stock of the
second company will continue until the values of both companies are not equalized.
Most of Modigliani and Miller assumptions (odigliani and iller 1958), of
course, are unrealistic. Some assumptions can be removed without changing the
conclusions of the model. However, assuming no costs of bankruptcy and the
absence of taxes (or the presence of corporate taxes only) are crucialthe change
of these assumptions alters conclusions. The last two assumptions rule out the
possibility of signaling theory and agency costs theory and, thus, also constitute a
critical prerequisite (Fig. 2.2).
2.2.2 ModiglianiMiller Theory with Taxes
In the real situation, taxes on profit of companies always exist. Since the interest
paid on debt are excluded from the tax baseit leads to the so-called effect of tax
shield: value of the company that used the borrowed capital (leverage company) is
higher than the value of the company that financed entirely by the equity

equity cost ke and WACC
on leverage level L within
ModiglianiMiller theory
without taxes
(non-leverage company). The value of the tax shield for 1 year is equal to kdDT,
where Dthe value of debt, Tthe income tax rate, and kdthe interest on the
debt (or debt capital cost) (odigliani and iller 1963). The value of the tax
shield for perpetuity company for all time of its existence is equal to (we used the
formula for the sum of terms of an infinitely decreasing geometric progression)
X
1
PVTS kd DT 1 kd t DT 2:5
t1
and the cost of leverage company is equal to
V V 0 DT, 2:6
where V0 is the value of financially independent company.

Thus, we obtain the following result obtained by odigliani and iller (1963):
The value of financially dependent company is equal to the value of the
company of the same risk group used no leverage, increased by the value of tax
shield arising from financial leverage, and equal to the product of rate of
corporate income tax T and the value of debt D.
Let us now get the expression for the equity capital cost of the company under
the existence of corporate taxes.
Accounting that V 0 CF=k0 and that the ratio of debt capital wd D=V, one
gets
V CF=k0 wd VT: 2:7
Because the value of leverage company is V CF=WACC, for weighted average

cost of capital, WACC, we get
WACC k0 1 wd T : 2:8
From here the dependence of WACC on leverage L D=S becomes the following:
WACC k0 1 LT=1 L: 2:9
On the other hand, on definition of the weighted average cost of capital with tax
shield accounting, we have
WACC k0 we kd wd 1 T : 2:10
Equating Eqs. (2.9) and (2.11), one gets
k0 1 wd T k0 we kd wd 1 T 2:11
and from here, for equity cost, we get the following expression:
1 w d T wd 1 wd D
ke k0 kd 1 T k0 k0 T kd 1 T
we we we we S
DS D D
k0 k0 T kd 1 T k0 L1 T k0 kd : 2:12
S S S
So, we get the following statement obtained by odigliani and iller (1963):
Equity cost of leverage company ke paying tax on profit could be found as
equity cost of financially independent company k0 of the same group of risk,
plus premium for risk, the value which is equal to production of difference
k0 kd on leverage level L and on tax shield (1 T).
It should be noted that the formula (Eq. 2.12) is different from the formula
(Eq. 2.4) without tax only by the multiplier (1 T ) in term, indicating a premium for
risk. As the multiplier is less than unit, the corporate tax on profits leads to the fact
that capital is growing with the increasing of financial leverage, slower than it
would have been without them.
Analysis of formulas (Eqs. 2.4, 2.9, and 2.12) leads to following conclusions.
When leverage grows:
1. Value of company increases.
2. Weighted average cost of capital WACC decreases from k0 (at L 0) up to k0
1 T (at L 1) (when the company is funded solely by borrowed funds).
3. Equity cost increases linearly from k0 (at L 0) up to 1 (at L 1).

equity capital cost, debt cost,
and WACC on leverage in
ModiglianiMiller theory
without taxes (t 0) and
with taxes (t 6 0)
Within their theory, odigliani and iller (1963) had come to the following
conclusions. With the growth of financial leverage (Fig. 2.3):
1. The company value increases.
2. The weighted average cost of capital decreases from k0 (for L 0) up to k0
1 T (for L 1, when the company is financed entirely with borrowed
funds).
3. The cost of equity capital increases linearly from k0 (for L 0) up to 1 (for
L 1).
2.2.3 Main Assumptions of ModiglianiMiller Theory
The most important assumptions of the ModiglianiMiller theory are as following:

1. Investors are behaving rationally and instantaneously, see profit opportunity,
inadequate investment risk. Therefore, the possibility of a stable situation of the
arbitration, i.e., obtain the risk-free profit on the difference in prices for the
same asset cannot be kept any length of timereasonable investors quickly
take advantage of it for their own purposes and equalize conditions in the
market. This means that in a developed financial market capital, the same risk
should be rewarded by the same rate of return.
2. Investment and financial market opportunities should be equally accessible to
all categories of investorswhether institutional or individual investors, large
or small, rapidly growing or stable, or experienced or relatively inexperienced.
3. Transaction costs associated with funding are very small. In practice, the
magnitude of transaction costs is inversely proportional to the amount of
finance involved, so this assumption is more consistent with reality than the
large sums involved: i.e., in attracting small amounts, the transaction costs can
be high, while, as in attracting large loans, as well as during placement of shares
at a significant amount, the transaction costs can be ignored.
4. Investors get money and provide funds to borrowers at risk-free rate. In all
probability, this assumption is due to the fact that the lender seeks to protect
himself by using one or other guarantees, pledge of assets, the right to pay
claims on third parties, and the treaty provisions restricting the freedom of the
borrower to act to the detriment of the creditor. Lenders risk is really small, but
its position can be considered risk free with respect to the position of the
borrower and, accordingly, should be rewarded by a risk-free rate of return.
5. Companies have only two types of assets: risk-free debt capital and risky equity
capital.
6. There is no possibility of bankruptcy, i.e., irrespective of what the level of
financial leverage of the companyborrowers are reachedbankruptcy is not
threatening them. Thus, bankruptcy costs are absent.
7. There are no corporate taxes and taxes on personal income of investors. If the
personal income tax can indeed be neglected, because the assets of the com-
pany separated from the assets of shareholders, the corporate income taxes
should be considered in the development of more realistic theories (which was
done by Modigliani and Miller in the second paper devoted to the capital
structure.
8. Companies are in the same class of risky companies.
9. All financial flows are perpetuity.
10. Companies have the same information.
11. Management of the company maximizes the capitalization of the company.
2.2.4 Modifications of ModiglianiMiller theory
Taking into Account Market Risk: Hamada Model Robert Hmd (1969)
unites Capital Asset Pricing Model (CAPM) with ModiglianiMiller model taxa-
tion. As a result, he derived the following formula for calculation of the equity cost
of financially dependent company, including both financial and business risk of
company:
D
ke kF kM kF bU kM kF bU 1 T ; 2:13
S
where bU is the -coefficient of the company of the same group of business risk, that
the company under consideration, but with zero financial leverage. The formula
(Eq. 2.13) represents the desired profitability of equity capital ke as a sum of three
components: risk-free profitability kF, compensating to shareholders a temporary
value of their money, premium for business risk kM kF bU , and premium for
financial risk kM kF bU DS1 T .
If the company does not have borrowing (D 0), the financial risk factor will be
equal to zero (the third term is drawn to zero), and its owners will only receive the
premium for business risk.
To apply the Hamada equation, specialists in practice, in most cases, use book
value of equity capital as its approach of market value. Nevertheless, the Hamada
formula implies the use of market value of the assets.
It should be noted also that the formula (Eq. 2.13) can be used to derive other
equation, using which you can analyze the impact of financial leverage on -factor
of company shares.
Equating CAPM formula to equity cost, we get:
D
kF kM kF bU kF kM kF bU kM kF bU 1 T 2:14
S
or

D
b bU 1 1 T : 2:15
S
In this way, the assumptions on which ModiglianiMiller theory and CAPM are
based, -factor of equity capital of financially dependent company is equal to -
factor of financially independent company, corrected on tax on profit rate and
applied leverage level. Consequently, market risk of the company, measured by a
factor b, depends on both the business risk of the company, a measure of which is
bU, , and on the financial risk b, which is calculated by the formula (Eq. 2.15).
In conclusion, here are the formulas for calculating the capital costs within the
CAPM model [in parenthesis, there are formulas within the ModiglianiMiller
theory (Modigliani and Miller 1958, 1963, 1966)].
The equity cost for company without debt capital:

ke kF kM kF U , ke k0 : 2:16
The equity cost for company with debt capital:

ke kF kM kF e , ke k0 1 T k0 kd L: 2:17
The debt cost:

kd kF kM kF d , kd kF ; d 0: 2:18
The weighted average cost of capital WACC

WACC ke we kd wd 1 T , WACC k0 1 Twd : 2:19
The Cost of Capital Under Risky Debt Another hypothesis of Modigliani and
Miller was the suggestion about free of risk debt (in their theory, there are two types
of assets: risky equity and free of risk debt). However, if we assume the risk of
bankruptcy of company (and, accordingly, the ability to nonpayment of loans), the
situation may change. Stiglitz (1969) and Rubinstein (1973) have shown that the
conclusions concerning the total value of company do not change as compared to
the findings derived by Modigliani and Miller under assumptions about free of risk
debt (Modigliani and Miller 1958, 1963, 1966). However, the debt cost is changed.
If previously, under assumption about the free of risk debt, it (debt cost) was
regarded as a constant kd kF , now it is not a constant. This claim is based on
the work by Hsia (1981), where based on the models of pricing options,
ModiglianiMiller and CAPM, it was shown that if one uses the formula for the
net discount income, a term, reflecting tax protection on debt, should be discounted
at the rate
0 1
kd kF k0 kF N d1 ; 2:20
wd
where
lnwd kF t 1 p
d1 p k F t; 2:21
t 2
here ta moment of payment a credit, N d 1 cumulative normal distribution of

probability of random value d1.
The Account of Corporate and Individual Taxes (Miller Model) In the second
article, Modigliani and Miller (1963) considered taxation of corporate profits, but
did not take into account the presence in the economy of individual taxes of
investors.
Merton Miller (1997) has introduced the model, demonstrating impact of lever-
age on the company value with account of the corporate and individual taxes
(Miller 1976).
To describe his model, we will enter the following legends: TCtax on corpo-
rate profits rate, TSthe tax rate on income of an individual investor from his
ownership by stock of corporation, TDtax rate on interest income from the
provision of investorindividuals of credits to other investors and companies.
Income from shares partly comes in the form of a dividend and, in part, as capital
profits, so that TS is a weighted average value of effective rates of tax on dividends
and capital profits on shares, while the income from the provision of loans usually
comes in the form of the interests. The last are usually taxed at a higher rate. In the
light of the individual taxes, and with the same assumptions that have been made for
ModiglianiMiller models previously, the financially independent company value
can be determined as follows:
EBIT1 T C 1 T S
VU : 2:22
k0
A term 1 T S allows to take into account the individual taxes in the formula. In
this way, numerator indicates which part of the operating companys profit remains
in the possession of the investors, after the company will pay taxes on their profits,
and its shareholders then will pay individual taxes on income from stock ownership.
Since individual taxes reduce profits, remaining in the disposal of investors, the last,
at other things being equal circumstances, also reduce and an overall assessment of
the financially independent company value.
We will assess the financially dependent company under condition of a double
taxation of income investors. To start, let us divide the annual cash flows of
financially dependent company CFL into flows sent to its shareholders CFe and
the flows belonging to debt owners CFd, with account of both corporation tax on
profits and on the income of individuals:
CFL CFe CFd EBIT I 1 T C 1 T S I 1 T D ; 2:23
where I is the annual interest payments on debt.

The formula (Eq. 2.23) can also be rewritten as follows:
CFL CFe CFd EBIT1 T C 1 T S I 1 T C 1 T S

I 1 T D : 2:24
The first term of the equation (Eq. 2.24) corresponds to cash flow after taxes for
financially independent company, shown in equation (Eq. 2.22), which shows its
present value. The second and the third terms of the equation, reflecting the
financial dependence, corresponds to cash flows related to the debt financing,
which, as previously, is considered as free of risk. Their present values are obtained
by discounting by risk-free nominal rate on debt kd.
By combining the present values of all three terms, we get the company value
under using the debt financing and in the presence of all types of taxation:
EBIT1 T C 1 T S I 1 T C 1 T S I 1 T d
VU : 2:25
k0 kd kd
First term in (Eq. 2.25) is identical to VU in formula (Eq. 2.22). Accounting this
and combining two last terms, we get the following formula:

I 1 T d 1 T C 1 T S
VL VU 1 : 2:26
kd 1 T d
The amount of paid interests with taking into account the taxation, divided by the
desired profitability of debt capital,
I 1 T d
2:27
kd
is equal to market value of the debt D. Substituting D in the previous formula, we

get the final expression, which is known as a formula of a Miller model:

1 T C 1 T S
VL VU 1 D: 2:28
1 T d
The Miller model allows you to obtain an estimate of the value of financially
dependent company, taking into account the corporate tax, as well as tax on
individuals. The Miller formula (Eq. 2.28) has several important consequences:
1. Second term of sum,

1 T C 1 T S
1 D; 2:29
1 T d
represents the gains from use of debt capital. This term replaces the tax on profit
of corporation rate in the ModiglianiMiller model with corporate taxes:
V L V U TD: 2:30
2. If we ignore taxes, a term (Eq. 2.29) will be equal to zero. Thus, in this case, the
formula (Eq. 2.28) is transformed into the original version of the Modigliani
Miller model without taxes.
3. If we neglect taxes on individuals, the considering term becomes
1 1 T C T C , so, in this case, (Eq. 2.28) becomes a ModiglianiMiller
model with corporate taxes (Eq. 2.30).
4. If the shareholder receives profit only in the form of dividend, and if effective tax
rates on income from shares and bonds are equal (T S T D), the terms 1 T S and
1 T D are shrinking, and the factor for D in (Eq. 2.29) again is equal to TC.
5. If the shareholder receives dividends, and income from capital, the situation is
changed.
In this case, effective tax rates on income from shares and bonds are not equal.
Lets take a look at common case, when individual taxes on income for the
company shares are less than individual taxes of creditors. This encourages
investors to purchase the shares of the company compared to purchasing the
bonds of the company. In this case, T S < T D . Then factor in D in (Eq. 2.28) has
a look
1 T C 1 T S
1 1 1 T C 1 1 T C 1
1 T d 2:31
T C T C 1 < T C :
It is less than TC, because > 0, T C < 1, therefore, in this case, the effect of
using of debt financing, although there is, but it is less, than in the absence of
individual taxes. In other words, the effect of tax shields for the company in this
case decreases, and it becomes less than the above individual taxes of creditors
(individual taxes for the obligations of the company) in comparison with the
individual income tax on shares.
6. Lets take a look at case T S > T D , when individual income taxes on shares are
bigger than individual taxes creditors. The factor takes view
1 T C 1 T S
1 1 1 T C 1 1 T C 1
1 T d 2:32
T C 1 T C > T C :
It is bigger than TC, because > 0, T C < 1; therefore, in this case, the effect of
use of debt financing is increased compared with the case of the absence of
individual taxes.
7. If 1 T C 1 T S 1 T D , then this term is zero, and the effect of using debt
financing will also be zero. This means that the benefits of the use of tax shields
as a result of the application of debt financing will be fully offset by additional
losses of investors, associated with a higher tax rate on interest on income of
individuals. In this case, the capital structure will not affect the company value
and its capital costin other words, you can apply ModiglianiMiller theory
without tax (odigliani and iller 1958).
In his report, Miller (1976) claimed that companies on average will use issuance
of shares and debt securities in such a way as to result in taxation of investors
income to be optimal. In such an equilibrium state will occur equality
1 T C 1 T S 1 T D ; 2:33
and thus, as we have pointed out above, capital structure will not affect the market
company value and its capital cost. Thus, by Miller, the conclusions on the
irrelevance of the capital structure, made on the base of the original Modigliani
Miller model with zero taxes, remain in force.
Subsequently, researchers adapted and checked the Miller results. Their works,
as a rule, have been devoted to the Millers conclusion concerning the absence of
the gains from the use of the debt capital by the company. In the United States, an
effective tax rate on the income of shareholders is lower than the one on the income
of creditors, but, nevertheless, the product 1 T C 1 T S is less than 1 T D .
Consequently, the companies may receive the benefit from use of debt financing.
However, in the Millers work, in fact, has been shown that the distinction of rates
of individual taxes on income of shareholders and creditors to some extent com-
pensates the advantages of use of debt financing, and, in this way, the tax benefits of
debt are less than anticipated at a more earlier ModiglianiMiller model, where
only corporate taxes have been taken into account.
In conclusion, we present in Table 2.1 classification and summary of main
theories of capital structures of company.
22
Table 2.1 Classification and summary of main theories of capital structures of company
Theory Main thesis
Traditional theory Empirical theory, existing before appearance of the first quantitative theory of capital structures (Modigliani
Miller theory) in 1958 (Modigliani and Miller 1958, 1963, 1966). Weighted average cost of capital depends on
capital structures of company. There is an optimal dependence on capital structures of company
Modigliani Without taxes Capital cost and capitalization of the company are irrelevant on the capital structures of company
Miller theory With taxes Weighted average cost of capital is decreased with leverage level, equity cost is increased linearly with leverage
() level, and capitalization of the company is increased with leverage level continuously
Brusov Without inflation BFO theory (Brusov and Filatova 2011; Brusov et al. 2011a, b, c, 2012a, b, 2013a, b, 2014a, b; Filatova
Filatova et al. 2008; Brusova 2011) has replaced the famous theory of capital cost and capital structure by Nobel
Orekhova the- laureates, Modigliani and Miller (1958, 1963, 1966). The authors have moved from the assumption of
ory (BFO) ModiglianiMiller concerning the perpetuity (infinite time of life) of companies and further elaborated
quantitative theory of valuation of core parameters of financial activities of companies with arbitrary lifetime
(arbitrary age). Results of modern BFO theory turn out to be quite different from that of ModiglianiMiller
theory. It shows that later, via its perpetuity, underestimates the assessment of weighted average cost of capital
and the equity cost of the company and substantially overestimates the assessment of the capitalization of the
company. Such an incorrect assessment of key performance indicators of financial activities of companies has
led to an underestimation of risks involved, and impossibility, or serious difficulties in adequate managerial
decision-making, which was one of the implicit reasons of global financial crisis of 2008 year. In the BFO
theory, in investments at certain values of return-on-investment, there is an optimum investment structure. As
well authors have developed a new mechanism of formation of the company optimal capital structure, different
from suggested by trade-off theory
With inflation Inflation not only increases the equity cost and the weighted average cost of capital, but as well it changes their
dependence on leverage. In particular, it increases growing rate of equity cost with leverage. Capitalization of
the company is decreased under accounting of inflation
With increased finan- In BFO theory, with increased financial distress costs and risk of bankruptcy, the optimal capital structure is
cial distress costs and absent, which means that trade-off theory does NOT work
risk of bankruptcy
2 Capital Structure: ModiglianiMiller Theory
Trade-off Static The static trade-off theory is developed with accounting of tax on profit and bankruptcy cost. It attempts to
theory explain the optimal capital structure in terms of the balancing act between the benefits of debt (tax shield from
interest deduction) and the disadvantage of debt (from the increased financial distress and expected bankruptcy
costs). The tax shield benefit is the corporate income tax rate multiplied by the market value of debt and the
expected bankruptcy costs are the probability of bankruptcy multiplied by the estimated bankruptcy costs
Does not take into account the costs of the adaptation of financial capital structure to the optimal one, economic
behavior of managers, owners, and other participants of economical process, as well as a number of other factors
As it has been shown in BFO theory, the optimal capital structure is absent in trade-off theory
Dynamic The dynamic trade-off models assume that costs of constant capital adjustment are high and thus firms will
change capital structure only if benefits exceed costs. Therefore, there is an optimal range, outside of each
2.2 ModiglianiMiller Theory
leverage changes but remains unchanged inside. Companies try to adjust their leverage when it reaches the
boundary of the optimal range. Subject to types of adjustment costs firms reach target ratio faster or slower.
Proportional changes imply slight correction, whereas fixed changes imply considerable costs. In the dynamic
model, correct decision on financial structure capital of the company in this period depends on the profit, which
the company hopes to receive in the next period
In BFO theory, with increased financial distress costs and risk of bankruptcy, the optimal capital structure is
absent, which means that trade-off theory does NOT work: in static version as well as in dynamic one
Accounting of transaction cost Accounting of the recapitalization transaction costs for the company, in which these costs are high, leads to the
conclusion that a more cost-effective is not to modify financial capital structure, even if it is not optimal, during
a certain period of time. The actual and target capital structure may vary because of the tool costs
Accounting of asymmetry of information At the real financial markets, information is asymmetric (managers of the companies have owned more reliable
information than investors and creditors), and rationality of economic subjects is limited
Signaling theory Information asymmetry may be reduced on the basis of certain signals for creditors and investors, related to the
behavior of managers on the capital market. It should take into account the previous development of the
company and the current and projected cost-effectiveness of activities
Pecking order theory The pecking order theory is the preferred, and empirically observed, sequence of financing type to raise capital.
That is, firms first tap retained earnings (internal equity) finance, second source is debt, and the last source is
issuing new common stock shares (external equity). The empirical evidence of nonfinancial firm debt ratios
coupled with the decision-making process of top management and the board of directors point to greater
adherence to the pecking order theory
(continued)
23
Table 2.1 (continued)
24
Theory Main thesis

Theories of Theory of agency costs Management of the company may take decisions that are contrary to the interests of the shareholders or
conflict of creditors, respectively; the costs are necessary to monitor its actions. An effective tool for resolving agent
interests problem is the correct selection of compensation package (the share of participation of agent in property, bonus,
stock options), allowing to link revenue of managers with the dynamics of equity capital and to provide
motivation for managers to its (equity capital) conservation and growth
Theory of corporate If asymmetries of information exist, creditors, providing the capital, are interested in the possibility of the
control and costs implementation of the self-monitoring of the effectiveness of its use and return. Costs for monitoring, as a rule,
monitoring put on the company owners by their inclusion into credit rate. The level of monitoring costs depends on the scale
of the business; therefore, with the increase of the business scale, the weighted average cost of capital of the
company grows and company market value is reduced
Theory of stakeholders Stakeholder theory is a theory that identifies and models the groups that are stakeholders of a corporation or
project. The diversity and the intersection of stakeholders interests and different assessment by them of
acceptable risk generate conditions for conflict of their interest, that is, making some corrections into the process
of optimizing financial capital structure
Behavioral Manager investment Managers implement those decisions, which, from their point of view, will be positively perceived by investors
theories autonomy and, respectively, positively affect the market value of companies: when the market value of shares of a
company and the degree of consensus of expectations of managers and investors are high, the company has an
additional issue of shares, and in the opposite situation, it uses debt instruments. In this way, the financial capital
structure is more influenced by investors, the expectations of which are taken into account by managers
The equity market Leverage level is determined by market dynamics. Equity market timing theory means that company should
timing theory issue shares at high price and repurchase them at low price. The idea is to exploit temporary fluctuations in the
equity cost relative to the cost of other forms of capital
Information cascades In order to save costs and to avoid errors, financial capital structure can be formed not on the basis of the
calculations of optimal capital structure or depending on available in different periods of company life funding
sources, but borrow from other companies that have successful, reputable managers (companies leaders), as
well as using (in the wake of the majority) the most popular methods of management of capital structure
2 Capital Structure: ModiglianiMiller Theory
References 25
References
theory of ModiglianiMiller, modified for a finite life-time company. Appl Financ Econ 21
(11):815824
Brusov P, Filatova T, Orehova N, Brusov PP, Brusova N (2011b) From ModiglianiMiller to
general theory of capital cost and capital structure of the company. Res J Econ Bus ICT
2:1621
http://dx.doi.org/10.1080/23322039.2014.946150
Brusova A (2011) A comparison of the three methods of estimation of weighted average cost of
Filatova , Orehova N, Brusova A (2008) Weighted average cost of capital in the theory of
ModiglianiMiller, modified for a finite lifetime company. Bull FU 48:6877
Hamada R (1969) Portfolio analysis, market equilibrium, and corporate finance. J Financ 24
(1):1331
Hsia (1981) Coherence of the modern theories of finance. Financ Rev 16(1):2742
Miller M (1976) Debt and taxes. J Financ 32(2):261275
Miller M (1997) Merton Miller on Derivatives. New York, NY: Wiley
Econ Rev 53:147175
19541957. Am Econ Rev 56:333391
Rubinstein M (1973) A meanvariance synthesis of corporate financial theory. J Financ
28:167181
Stiglitz J (1969) A re-examination of the ModiglianiMiller theorem. Am Econ Rev 59
(5):784793
Chapter 3
Modern Theory of Capital Cost and Capital
Structure: BrusovFilatovaOrekhova
Theory (BFO Theory)
One of the serious limitations of the ModiglianiMiller theory is the suggestion

about perpetuity of the companies. In 2008, BrusovFilatovaOrekhova (Filatova
et al. 2008) have lifted up this limitation and have shown that the accounting of the
finite lifetime of the company leads to significant changes of all ModiglianiMiller
results (Modigliani and Miller 1958, 1963, 1966): capitalization of the company is
changed, as well as the equity cost, ke, and the weighted average cost of capital,
WACC, in the presence of corporate taxes. Besides, a number of qualitatively new
effects in corporate finance, obtained in BrusovFilatovaOrekhova theory (Brusov
and Filatova 2011; Brusov et al. 2011a, b, c, 2012a,b, 2013a,b, 2014a,b), are absent
in ModiglianiMiller theory.
Only in the absence of corporate taxes, we give a rigorous proof of the Brusov
FilatovaOrekhova theorem that equity cost, ke, as well as its weighted average
cost, WACC, does not depend on the lifetime (or age) of the company, so the
ModiglianiMiller theory could be generalized for arbitrary lifetime (arbitrary age)
companies.
Until recently (before 2008, when the first paper by BrusovFilatovaOrekhova
(Filatova et al. 2008) has appeared), the basic theory (and the first quantitative one)
of the cost of capital and capital structure of companies was the theory by Nobel
Prize winners Modigliani and Miller (Modigliani and Miller 1958, 1963, 1966).
One of the serious limitations of the ModiglianiMiller theory is the suggestion
about perpetuity of the companies. We lift up this limitation and show that the
accounting of the finite lifetime (finite age) of the company leads to change of the
equity cost, ke, as well as of the weighted average cost of capital, WACC, in the
presence of corporate taxes. The effect of leverage on the cost of equity capital of
the company, ke, with an arbitrary lifetime, and its weighted average cost of WACC
is investigated. We give a rigorous proof of the BrusovFilatovaOrekhova theo-
rem that in the absence of corporate taxes, cost of company equity, ke, as well as its
weighted average cost, WACC, does not depend on the lifetime of the company.

DOI 10.1007/978-3-319-14732-1_3
28 3 Modern Theory of Capital Cost and Capital Structure: BrusovFilatova-. . .
3.1 Companies with Arbitrary Lifetime (Arbitrary Age):

BrusovFilatovaOrekhova Equation
Let us consider the situation with finite lifetime (finite age) companies. First of all,
we will find the value of tax shield, TS, of the company for n years
X
n
TS kd DT 1 kd t DT1 1 kd n : 3:1
t1
(We used the formula for the sum of n terms of a geometric progression).
Here, D is the value of debt capital; kd the cost of debt capital; and T the tax on
profit rate.
Next, we use the ModiglianiMiller theorem (Modigliani and Miller 1958, 1963,
1966):
The value of financially dependent company is equal to the value of the
company of the same risk group used no leverage, increased by the value of tax
shield arising from financial leverage, and equal to the product of rate of
corporate income tax T and the value of debt D.
V V 0 DT : 3:2
This theorem was formulated by Modigliani and Miller for perpetuity companies,
but we modify it for a company with a finite lifetime.
X
1
V V 0 TS V 0 kd DT 1kd t
t1
3:3
V 0 wd VT 1 1 kd n ;
V 1 wd VT 1 1 kd n V0: 3:4
There is a common use of the following two formulas for the cost of the financially
independent and financially dependent companies (Modigliani and Miller 1958,
1963, 1966):
V 0 CF=k0 and V CF=WACC: 3:5
However, these almost always used formulas were derived for perpetuity company,
and in case of a company with a finite lifetime (or finite age), they must be modified
in the same manner as the value of tax shields (Brusov and Filatova 2011; Brusov
et al. 2011a, b, c, 2012a, b, 2013a, b, 2014a, b; Filatova et al. 2008):
V 0 CF1 1 k0 n =k0 ; V CF1 1 WACCn =WACC: 3:6
From formula (Eq. 3.4), we get BrusovFilatovaOrekhova equation for WACC

3.1 Companies with Arbitrary Lifetime (Arbitrary Age): BrusovFilatova-. . . 29
(Brusov and Filatova 2011; Brusov et al. 2011a, b, c, 2012a,b, 2013a,b, 2014a,b;
Filatova et al. 2008):
1 1 WACCn 1 1 k0 n
: 3:7
WACC k0 1 d T 1 1 kd n
Here, Sthe value of equity capital of the company, wd DS D

the share of debt
capital, ke , we DS
S
the cost and the share of the equity capital of the company,
and L D=Sfinancial leverage.
At n 1, we get Myers (Myers 2001) formula for 1-year company
1 k0 kd
WACC k0 wd T 3:8
1 kd
For n 2, one has
1 1 WACC2 1 1 k0 2
h i : 3:9
WACC k0 1 d T 1 1 kd 2
This equation can be solved for WACC analytically:

p
1 2 4 1
WACC ; 3:10
2
where
2 k0
h i: 3:11
2 2kd k2d
1 k0 1 d T 1k 2
d
For n 3 and n 4, equation for the WACC becomes more complicated, but it still
can be solved analytically, while for n > 4, it can be solved only numerically.
We would like to make an important methodological notice: taking into
account the finite lifetime of the company, all formulas, without exception, should
be received with use formulas (Eq. 3.6) instead of their perpetuity limits (Eq. 3.5).
Below, we will describe the algorithm for the numerical solution of the equation
(Eq. 3.7).
Algorithm for Finding WACC in Case of Arbitrary Lifetime of the Project
Let us return back to n-year project (n-year company). We have the following
equation for WACC in n-year case:
1 1 WACCn
An 0; 3:12
WACC
Where,
1 1 k0 n
An : 3:13
k0 1 d T 1 1 kd n
The algorithm of the solving of the Eq. (3.12) should be as follows:

1. Putting the values of parameters k0, d, T and given n, we calculate A(n);
2. We determine two WACC values, for which the left part of the equation (3.12)
has opposite signs. It is obvious that as these two values we can use WACC1 and
WACC1 , because WACC1 > WACCn > WACC1 for finite n 2.
3. Using, for example, the bisection method, we can solve the Eq. (3.12)
numerically.
In MS Excel, it is possible to solve the Eq. (3.7) much easily by using the option
matching of parameter: we will use it through the monograph.
3.2 Comparison of ModiglianiMiller Results (Perpetuity

Company) with Myers Results (1-Year Company)
and BrusovFilatovaOrekhova Ones (Company
with Arbitrary Lifetime (Arbitrary Age))
Myers (2001) has compared his result for 1-year project (Eq. 3.8) with Modigliani
and Millers result for perpetuity limits (Eq. 2.8). He has used the following values
of parameters:
k0 8 % 24 %; kd 7 %; T 50 %; wd 0 % 60 %
and estimated the difference in the WACC values following from the formulas
(Eqs. 3.8 and 2.8). We did make the similar calculations for 2-, 3-,5-, and 10-year
project for the same set of parameters, and we have gotten the following results,
shown in Tables [Table 3.1 (second line (bulk)), Table 3.2 (second line (bulk)), and
Table 3.3)] and corresponding figures (Figs. 3.1, 3.2, and 3.3).
Note that data for equity cost k0 8 % turn out to be a little bit uncertain: this
could be related to the fact that this value of equity cost is quite close to value of
interest rate of the debt kd 7 %. For all other values of equity cost, the results are
reproducible and very informative and are discussed below.
For a graphic illustration of the results, we use data for n 1, 2, 1, which
adequately reflect the results we have obtained.
3.2 Comparison of ModiglianiMiller Results (Perpetuity Company) with Myers. . . 31
Table 3.1 WACC dependence on debt share wd for different values of equity cost k0 for
companies with different lifetime n
k0 n wd 10% 20 % 30 % 40 % 50 % 60 %
k0 8 % n1 7.6 % 7.3 6.9 6.6 6.2 5.9
n2 7.52 7.08 6.6 6.17 5.67 5.21
n1 7.6 7.2 6.8 6.4 6.0 5.6
k0 10 % n1 9.7 9.3 8.9 8.6 8.2 7.8
n2 9.51 9.05 8.59 8.13 7.64 7.16
n1 9.5 9.0 8.5 8.0 7.5 7.0
k0 12 % n1 11.6 11.3 10.9 10.5 10.2 9.8
n2 11.51 11.02 10.54 10.07 9.6 9.09
n3 11.46 10.93 10.39 9.85 9.31 8.77
n5 11.42 10.83 10.25 9.66 9.06 8.46
n 10 11.396 10.786 10.1695 9.5455 8.914 8.2745
n1 11.4 10.8 10.2 9.6 9.0 8.4
k0 16 % n1 15.62 15.2 14.9 14.5 14.1 13.7
n2 15.52 14.99 14.5 13.98 13.47 12.96
n3 15.44 14.88 14.31 13.75 13.18 12.61
n5 15.38 14.76 14.14 13.51 12.88 12.24
n 10 15.34 14.67 13.99 13.31 12.62 11.92
n1 15.2 14.4 13.6 12.8 12.0 11.2
k0 20 % n1 19.6 19.2 18.8 18.4 18.1 17.7
n2 19.45 18.97 18.45 17.93 17.37 16.86
n3 19.41 18.82 18.23 17.64 17.05 16.45
n5 19.35 18.69 18.03 17.36 16.70 16.03
n 10 19.27 18.54 17.80 17.05 16.30 15.54
n1 19.0 18.0 17.0 16.0 15.0 14.0
k0 24 % n1 23.6 23.2 22.8 22.4 22.0 21.6
n2 23.46 22.94 22.37 21.80 21.30 20.75
n3 23.39 22.77 22.15 21.54 20.91 20.29
n5 23.31 22.61 21.91 21.21 20.51 19.80
n 10 23.21 22.40 21.60 20.78 19.96 19.13
n1 22.8 21.6 20.4 19.2 18.0 16.8
Discussion of Results
1. From Table 3.1 and Fig. 3.1, it is obvious that WACC is maximum for 1-year
company (project) and decreases with the lifetime (age) of the company (pro-
ject) and reaches the minimum in the ModiglianiMiller perpetuity case. Depen-
dence of all WACC values on debt share wd turns out to be linear at any equity
cost k0 for all considered durations of the project (lifetime values of the compa-
nies). It is natural for 1-year project because it is described by Myers linear
formula (3.8) as well as, in the ModiglianiMiller perpetuity case, described by
the formula (2.8), which is linear too, but it is surprise for 2-year project, where
formula for WACC (3.7) is obviously nonlinear.
The negative slope in WACC increases with the equity cost k0.
Table 3.2 Dependence of the differences 1 WACC1 WACC1 (first line), 2 WACC1
WACC2 [second line (bulk)], and their ratio r 1 =2 (third line) on debt share wd for different
values of equity cost k0
wd 10 % 20 % 30 % 40 % 50 % 60 %
k0 10 % 0.20 0.30 0.4 0.60 0.7 0.8
0.19 0.25 0.31 0.47 0.56 0.64
1.05 1.2 1.29 1.28 1.25 1.25
k0 12 % 0.2 0.5 0.7 0.9 1.2 1.4
0.09 0.28 0.36 0.43 0.6 0.71
2.22 1.76 1.94 2.09 2 1.97
k0 16 % 0.4 0.8 1.3 1.7 2.1 2.5
0.08 0.21 0.4 0.52 0.63 0.74
5.0 3.81 3.25 3.27 3.33 3.38
k0 20 % 0.6 1.2 1.8 2.4 3.1 3.7
0.15 0.23 0.35 0.47 0.73 0.84
4.0 5.22 5.14 5.11 4.25 4.4
k0 24 % 0.8 1.6 2.4 3.2 4.0 4.8
0.14 0.26 0.43 0.6 0.7 0.85
5.7 6.15 5.58 5.33 5.71 5.65
Table 3.3 Average (by debt share wd) values of ratios r h1 =2 i for k0 10 %; 12 %; 16 %;
20 %; and 24 %
k0 10 % 12 % 16 % 20 % 24 %
r < 1 =2 > 1.22 2.00 3.67 4.69 5.69
2. As it follows from the Table 3.2 and Fig. 3.3, the dependence of the average
ratios r h1 =2 i on debt share wd is quite weak and can be considered as
almost constant. The value of this constant increases practically linear with the
equity cost k0 from 1.22 at k0 10 % up to 5.69 at k0 24 % (see Fig. 3.4).
3. The relative difference between 1-year and 2-year projects increases when the
equity cost k0 decreases. At the same time, the relative difference between 2-year
project and perpetuity MM project increases with the equity cost k0.
3.3 BrusovFilatovaOrekhova Theorem
Case of Absence of Corporate Taxes

ModiglianiMiller theory in case of absence of corporate taxes gives the following
results for dependence of WACC and equity cost ke on leverage:
3.3 BrusovFilatovaOrekhova Theorem 33
25.00
24.00
23.00
22.00
21.00
20.00
19.00
18.00
17.00
16.00
WACC
15.00
14.00
13.00
12.00
11.00
10.00
9.00
8.00
7.00
6.00
5.00
0 10 20 30 40 50 60
Wd
Fig. 3.1 The dependence of the WACC on debt share wd for companies with different lifetimes
for different cost of equity, k0 (from Table 3.1)
Fig. 3.2 Dependence of the ratio r 1 =2 of differences 1 WACC1 WACC1 and 2

WACC1 WACC2 on debt share wd for different values of equity cost k0 (from Table 3.2)
1.
V0 VL; CF=k0 CF=WACC, and thus WACC k0 : 3:14
2. WACC we ke wd kd ; and thus

Fig. 3.3 Dependence of the average values of ratio r h1 =2 i on the equity cost, k0
Fig. 3.4 The dependence of the WACC on leverage in the absence of corporate taxes [the
horizontal line (t 0)], as well as in the presence of corporate taxes [for 1-year (n 1) and
perpetuity companies (n 1)]. Curves for the WACC of companies with an intermediate lifetime
(age) (1 < n < 1) lie within the shaded region
L
WACC wd kd k0 1 Lkd
ke
we 1 3:15
1L
k0 Lk0 kd :
For the finite lifetime (finite age) companies, ModiglianiMiller theorem about
equality of value of financially independent and financially dependent companies
V 0 V L has the following view (Brusov and Filatova 2011; Brusov et al. 2011a,
b, c, 2012a, b, 2013a, b, 2014a, b):
3.3 BrusovFilatovaOrekhova Theorem 35
V0 VL;
n
1 1 k 0 1 1 WACCn
CF CF : 3:16
k0 WACC
Using this relation, we prove an important BrusovFilatovaOrekhova theorem:

Under the absence of corporate taxes, the equity cost of the company, ke, as
well as its weighted average cost of capital, WACC, does not depend on the
lifetime (age) of the company and is equal, respectively, to
k e k 0 L k 0 k d ; WACC k0 : 3:17
Let us consider first the 1- and 2-year companies

(a) For 1-year company, one has from (3.15)
1 1 k0 1 1 1 WACC1
; 3:18
k0 WACC
and thus
1 1
: 3:19
1 k0 1 WACC
Hence
WACC k0 : 3:20
Formula for equity cost ke k0 Lk0 kd now obtained by substituting

WACC k0 into (3.14).
(b) For 2-year company, one has from (3.15)
h i h i
1 1 k0 2 1 1 WACC2
;
k0 WACC
and thus
2 k0 2 WACC
2
: 3:21
1 k 0 1 WACC2
Denoting 1k
2k0
2
, we get the following quadratic equation for WACC:
0
WACC2 2 1 WACC 2 0: 3:22
It has two solutions

p
1 2 4 1
WACC1, 2 : 3:23
2
Substituting 1k
2k0
2
, we get
0

k20 3 k0 31 k0
WACC1, 2 : 3:24
2 2 k 0
2k0 3
WACC1 k0 ; WACC2 < 0: 3:25
k0 2
The second root is negative, but the weighted average cost of capital can only
be positive, so only one value remains
WACC1 k0 :
(c) For company with arbitrary lifetime, n, BrusovFilatovaOrekhova formula

(3.15) gives
1 1 k0 n 1 1 WACCn
: 3:26
k0 WACC
For a fixed k0, (Eq. 3.25) is an equation of (n + 1)-degree relative to WACC. It

has n + 1 roots (in general complex). One of the roots, as a direct substitution
shows, is always WACC k0 :. Investigation of the remaining roots is difficult
and not a part of our problem.
Formula for equity cost ke k0 Lk0 kd is now obtained by substitut-
ing WACC k0 into (Eq. 3.14).
Thus, we have proved the BrusovFilatovaOrekhova theorem.
Case of the Presence of Corporate Taxes
ModiglianiMiller theory in case of presence of corporate taxes gives the following
results for dependence of WACC and equity cost ke on leverage:
1. WACC
V L V 0 Dt; D wd V L ; 3:27
CF=WACC CF=k0 Dt CF=k0 wd t CF=WACC; 3:28
1 wd t 1
; 3:29
WACC k0

L
WACC k0 1 wd t k0 1 t : 3:30
1L
Thus, WACC decreases with leverage from k0 [in the absence of debt financing
(L 0)] up to k0 1 t (at L 1).
3.4 From ModiglianiMiller to General Theory of Capital Cost and Capital Structure 37
(2) The equity cost ke
WACC k0 1 wd t we ke wd kd 1 t;
and thus
WACC wd kd 1 t
ke
we
L
k0 1 wd t kd 1 t 3:31
1L k0 Lk0 kd 1 t:
1
1L
3.4 From ModiglianiMiller to General Theory of Capital

Cost and Capital Structure
Let us consider, how the weighted average cost of capital, WACC, and the cost of
equity capital, ke, will be changed when taking into account the finite lifetime (finite
age) of the company.
(a) 1-year company
From (3.7), one has
1 1 WACCn 1 1 k0 n
: 3:32
WACC k0 1 wd t1 1 kd n
For 1-year company, we get
1 1 WACC1 1 1 k0 1
h i 3:33
WACC k0 1 wd t 1 1 kd 1
From (Eq. 3.33), we obtain the well-known Myers formula (Eq. 3.8), which is
the particular case of BrusovFilatovaOrekhova formula (Eq. 3.7).
1 k0
WACC k0 kd wd t:
1 kd
Thus

1 k0 kd L
WACC k0 1 t : 3:34
1 kd k0 1 L
leverage from k0 [in the absence of debt financing

Thus, WACCdecreases with
(L 0)] up to k0 1 1k 0 k d
1kd k0 t at L 1:
Equating the right part of Eq. (3.34) to general expression for WACC
WACC we ke wd kd 1 t; 3:35
one gets
1 k0
k0 kd wd t we ke wd kd 1 t: 3:36
1 kd
Thus

1 1 k0
ke k0 kd wd t kd wd 1 t
we 1 kd
kd
1 Lk0 L 1 k0 t 1 kd 1 t
1 kd
kd
k0 Lk0 kd 1 t :
1 kd

kd
k e k 0 L k 0 k d 1 t : 3:37
1 kd
So we see that in case of 1-year company, the perpetuity limit

ke k0 Lk0 kd 1 t is replaced by (Eq. 3.37).
Difference is due to different values of the tax shield for a 1-year company and
perpetuity one (Fig. 3.5).
Let us investigate the question of the tax shield value for companies with
different lifetime (age) in more detail.
Tax Shield
General expression for the tax shield for n-year company has the form (Brusov
FilatovaOrekhova)
X
n
kd Dt kd Dt1 1 kd n
TS Dt1 1 kd n : 3:38
i1 1 kd i 1 k d 1 1 k d 1
1. In perpetuity limit n ! 1, tax shield is equal to TS1 Dt, which leads to the
so-called effect of the tax shield associated with the appearance of a factor
1 t in the equity cost ke k0 Lk0 kd 1 t.
2. For the 1-year company, tax shield value is equal to

TS1 Dt 1 1 kd 1 Dtkd =1 kd : 3:39

This leads to appearance of a factor 1 1k
kd
t in the equity cost (Eq. 3.36)
d
ke k0 Lk0 kd 1 1k
kd
d
t :
3.5 BFO Theory in the Case, When the Company Ceased to Exist at the Time Moment n 39
Fig. 3.5 Dependence of the

equity cost, ke, on leverage
in the absence of corporate
taxes [the upper line
(t 0)], as well as in the
presence of corporate taxes
[for 1-year (n 1) and
perpetuity companies
(n 1)]. Dependences of
the cost of equity capital of
companies, ke, with an
intermediate lifetime (1 < n
< 1) lie within the shaded
region
3. Tax shield for a 2-year company is equal to

TS2 Dt 1 1 kd 2 Dtkd 2 kd =1 kd 2 3:40
and if the analogy with 1-year company will keep, then factor 1 t in the
ModiglianiMiller theory would be replaced by the factor
!
k d 2 k d
1 t : 3:41
1 k d 2
However, due to a nonlinear relation between WACC and k0 and kd in Brusov

FilatovaOrekhova formula (Eqs. 3.9, 3.10, and 3.11) for 2-year company (and
companies with longer lifetime), such a simple analogy is no longer observed,
and the calculations become more complex.
3.5 BFO Theory in the Case, When the Company Ceased

to Exist at the Time Moment n
From the output of the BFO formula it follows that developed ideology is applied to
companies which have reached the age of n-years and continue to exist on the
market, while the theory of MM is only applicable to an infinitely old (perpetuity)
companies. By other words, BFO is applicable for most interesting case of compa-
nies that reached the age of n-years and continue to exist on the market, and allows
to analyze the financial condition of the operating companies.
However, the BFO theory allows also to examine the financial status of the
companies which ceased to exist, i.e., of those for which n means not age, but a life
time, i.e., the time of existence. A lot of schemes of termination of activities of the
company can exist: bankruptcy, merger, acquisition, etc. Below we consider one of
those schemes, when the value of the debt capital D becomes zero at the time of
termination of activity of company n: in this case the BFO theory requires minimal
upgrades, showed below.
From the formula for the capitalization of the company (3.1), it is easy to get an
estimation for the residual capitalization of the company, discounted to the time
moment k:
X
n
CF CF h nk
i
Vk 1 1 WACC : 3:42
tk1 1 WACCt WACC
Using the formula
V k wd D; 3:43
we obtain an expression for the tax shield for n years subject to the termination of
the activities of the company at the moment n:
X
n
V k1 tkd wd CF X
n
1 1 WACCnk1
TSn tkd wd
1 k d k WACC k1 1 k d k
k1
(3.44)
tkd wd 1 1 kd n 1 kd n 1 WACCn
:
WACC kd WACC kd
Substituting this expression into Eq. (3.3)
V L V 0 TSn
one gets the equation (let us call it BFO-2)

n
1 1 WACCn 1 1 k0

WACC k0

tkd wd 1 1 kd n 1 kd n 1 WACCn
;
WACC kd WACC kd
3:45
from which one can find the WACC for companies with arbitrary lifetime n,
provided that the company ceases to function at the time moment n.
Below in the monograph, we investigate the companies that have reached
the age of n-years and continue to exist on the market, i.e., we will use formula
BFO (3.7), but in this paragraph we present some results obtained from the
formula BFO-2 (3.45).
3.5.1 Application of Formula BFO-2
Formula BFO-2 (3.45) in MS Excel takes a following form:

1 1 C4H4 =C4 1 1 D4H4 =D4

G4*E4*F4=C4 * 1 1 E4H4 =E4 3:46

1 E4H4 1 C4H4 =C4 E4 0:
Using it we get the following results for dependence of WACC on leverage level L,
lifetime n, and on tax on profit rate t (Figs. 3.6, 3.7, and 3.8)
Fig. 3.6 The dependence

of the WACC on leverage WACC(L)
level L for n = 3 and n = 5; 0.2050
k0 0:2; kd 0:15
0.2000
0.1950
0.1900
WACC
0.1850
0.1800
0.1750
0.1700
0.1650
0 2 4 6 8 10 12
n
n=3 n=5

of the WACC on lifetime n WACC(n)
at different leverage level L 0.1900
0.1850
0.1800
WACC
0.1750
0.1700
0.1650
0.1600
0 10 20 30 40 50
n
L=1 L=2 L=3 L=5 L=7

of the WACC on tax on WACC(t)
profit rate t for n = 3 and 0.2500
n = 5; k0 0:2; kd 0:15
0.2000
0.1500
WACC
0.1000
0.0500
0.0000
0 0.2 0.4 0.6 0.8 1 1.2
n
n=3 n=5
WACC(L)
Fig. 3.9 Comparison of the
dependence of the WACC
on leverage level L for n = 3
and n = 5 from formulas 0.2100
BFO and BFO-2 0.2000
0.1900
WACC
0.1800
0.1700
0.1600
0.1500
0 5 10 15
L
n=3 n=5 n=3(2)
n=5(2)
3.5.2 Comparison of Results Obtained from Formulas BFO

and BFO-2
Let us compare results obtained from formulas BFO and BFO-2 (Figs. 3.9, 3.10,
3.11, and 3.12).
Comparison of results obtained from formulas BFO and BFO-2 shows that
WACC values (at the same values of other parameters) turn out to be higher for
the companies which ceased to exist at the time moment n, than for companies
which have reached the age of n-years and continue to exist on the market. By other
words, the companies which ceased to exist at the time moment n can attract a
Fig. 3.10 Comparison of

the dependence of the WACC(n)
WACC on lifetime n from
0.0760
formulas BFO (lower curve)
and BFO-2 (upper curve); 0.0740
k0 0:08; kd 0:04
0.0720
0.0700
WACC
0.0680
0.0660
0.0640
0.0620
0.0600
0 10 20 30 40 50
n
k0=0,08, kd=0,04 k0=0,08, kd=0,04

the dependence of the WACC(n)
WACC on lifetime n from 0.1800
formulas BFO (lower curve)
and BFO-2 (upper curve); 0.1750
k0 0:2; kd 0:15; L = 3
0.1700
WACC
0.1650
0.1600
0.1550
0.1500
0 10 20 30 40 50
n
k0=0,2; kd=0,15 k0=0,2, kd=0,15
capital at higher rate, than for companies which have reached the age of n-years and
continue to exist on the market.
We will develop the detailed investigation of the companies which ceased to
exist at the time moment n (described by formula BFO-2) somewhere also and in
this monograph we will limit ourselves by consideration of the companies which
have reached the age of n-years and continue to exist on the market (described by
formula BFO).

the dependence of the WACC(t)
WACC on tax on profit rate 0.2500
t from formulas BFO (lower
curve) and BFO-2 (upper 0.2000
curve); k0 0:2; kd 0:15;
n=5 0.1500
WACC
0.1000
0.0500
0.0000
0 0.2 0.4 0.6 0.8 1 1.2
n
n=5 n=5(2)
Conclusions In this chapter, an important step towards a general theory of capital

cost and capital structure of the company has been done. For this, perpetuity theory
of Nobel Prize winners Modigliani and Miller, which was until recently the basic
theory of capital cost and capital structure of companies, has been extended to the
case of companies with an arbitrary lifetime (arbitrary age), as well as for projects
of arbitrary duration.
We show that taking into account the finite lifetime (finite age) of the company
in the presence of corporate taxes leads to a change in the equity cost of the
company, ke, as well as in its weighted average cost, WACC, and company
capitalization, V.
Thus, we have removed one of the most serious limitations of the theory of
ModiglianiMiller, connected with the assumption of perpetuity of the companies.
The effect of leverage on the cost of equity capital of the company with an arbitrary
lifetime (arbitrary age), ke, and its weighted average cost, WACC, is investigated.
We give a rigorous proof of an important BrusovFilatovaOrekhova theorem that
in the absence of corporate tax, equity cost of companies, ke, as well as its weighted
average cost, WACC, does not depend on the lifetime (age) of the company.
We summarize the difference in results obtained within modern Brusov
FilatovaOrekhova theory and within classical ModiglianiMiller one in Table 3.4.
The first four formulas from the right-hand column are sometimes used in practice,
but there are several significant nuances. Firstthese formulas do not take account of
the residual value of the company, and only take into account the operating flows and
this must be borne in mind. Secondthese formulas contain the weighted average
cost of capital of the company, WACC. If it is estimated within the traditional
approach or the theory of ModiglianiMiller, it gives a lower WACC value, than
the real, and, therefore, overestimates the capitalization of both financially dependent
and financially independent companies. Therefore, in order to assess a companys
capitalization by the first two formulas, one needs to use BrusovFilatovaOrekhova
formulas for weighted average cost of capital, WACC, and equity cost, ke.
References 45
Table 3.4 Comparison of results, obtained within ModiglianiMiller theory and within general
BrusovFilatovaOrekhova theory
Financial ModiglianiMiller
parameter (MM) results BrusovFilatovaOrekhova (BFO) results
Capitalization of V 0 CF=k0 CF
V0 1 1 k0 n
financially inde- k0
pendent company
Capitalization of V CF=WACC CF
V 1 1 WACCn
leverage (finan- WACC
cially dependent)
company
Tax shield TS1 DT BFO: TSn DT 1 1 kd n
BFO-2:
T kd wd 1 1 kd n
TSn
WACC kd
n n
1 kd 1 WACC

WACC kd
Modigliani V V 0 DT V V 0 DT 1 1 kd n
Miller theorem
with taxes
Weighted average WACC BFO:
cost of capital, k0 1 wd t 1 1 WACCn
WACC
WACC
1 1 k0 n

k0 1 d T 1 1 kd n
BFO-2:
1 1 WACCn 1 1 k0 n Tkd wd

WACC k0 WACC
1 1 kd n 1 kd n 1 WACCn

kd WACC kd
Equity cost, ke ke k0 ke 1 L WACC
Lk0 kd 1 t kd L1 T
To calculate the equity cost in BFO approximation (last line in Table 3.4), one
first needs to use BrusovFilatovaOrekhova formula for weighted average cost of
capital, WACC (Brusov and Filatova 2011; Brusov et al. 2011a, b, c, 2012a,b,
2013a,b, 2014a,b; Filatova et al. 2008).
References
(11):815824

http://dx.doi.org/10.1080/23322039.2014.946150
Econ Rev 53:147175
19541957. Am Econ Rev 56:333391
Myers S (2001) Capital structure. J Econ Perspect 15(2):81102
Chapter 4
Bankruptcy of the Famous Trade-Off Theory
Within modern theory of capital cost and capital structure by BrusovFilatova

Orekhova (Brusov and Filatova 2011; Brusov et al. 2011a, b, c, 2012a, b, 2013a, b,
2014a, b; Filatova et al. 2008), the analysis of wide-known trade-off theory has
been made. It is shown that suggestion about risky debt financing (and about growth
of credit rate near the bankruptcy) in opposite to waiting result does not lead to
growth of weighted average cost of capital, WACC, which still decreases with
leverage. This means the absence of minimum in the dependence of WACC on
leverage as well as the absence of maximum in the dependence of company
capitalization on leverage. Thus, it means that the optimal capital structure is absent
in famous trade-off theory. The explanation to this fact has been done.
Under the condition of proved by us insolvency of well-known classical trade-
off theory, the question of finding of new mechanisms for the formation of a
companys optimal capital structure, different from one suggested by trade-off
theory, becomes very important. One of the real such mechanisms has been
developed by us in the next chapter.
4.1 Optimal Capital Structure of the Company
Choosing of optimal capital structure of the company, i.e., proportion of debt and
equity, which minimizes weighted average cost of capital, WACC, and maximizes
the company capitalization, V, is one of the most important tasks of financial
manager and the management of a company. The search for an optimal capital
structure, like the search for a golden fleece, attracts attention of economists and
financiers during many tens of years. And it is clear why: one can, nothing making,
but only by changing the proportion between the values of equity capital and debt
one of the company, significantly enhance the company capitalization, in other
words, to fulfill the primary task, to reach critical goal of the business management.

DOI 10.1007/978-3-319-14732-1_4
48 4 Bankruptcy of the Famous Trade-Off Theory
Spend a little less of your own, loan slightly more (or vice versa), and company
capitalization reaches the maximum.
Note that the problem of capital structure is studied very intensively. There are
theories that consider the perfect markets (Brusov and Filatova 2011; Brusov
et al. 2011a, b, c, 2012a, b, 2013a, b, 2014a, b; Filatova et al. 2008; Modigliani
and Miller 1958, 1963, 1966) and other ones that consider the imperfect markets
(Brennan and Schwartz 1978, 1984; Leland 1994; Kane et al. 1984; Dittmar and
Thakor 2007; Bikhchandani et al. 1998; Post et al. 2002; Filbeck et al. 1996; Jenter
2005; Baker and Wurgler 2002; Graham and Harvey 2001; Hovakimian et al. 2001;
Myers and Majluf 1984; Myers 1984; Fama and French 2004; Jensen et al. 1973).
Among latter ones we can mention agent cost theory (Jensen et al. 1973),
stakeholders theory (Post et al. 2002), manager investment autonomy (Dittmar
and Thakor 2007), information cascades (Bikhchandani et al. 1998), behavioral
theories (Filbeck et al. 1996; Jenter 2005; Baker and Wurgler 2002; Graham and
Harvey 2001); signaling theory (Myers and Majluf 1984), and pecking order theory
(Myers 1984; Hovakimian et al. 2001; Fama and French 2004). Historically, the
conceptions of the influence of capital structure on the well-being of shareholders
have developed not monotonically. We consider the traditional (empirical)
approach (Brusov and Filatova 2011; Brusov et al. 2011a, b, c, 2012a, b, 2013a,
b, 2014a, b; Filatova et al. 2008), the Modigliani and Miller theory (Modigliani and
Miller 1958, 1963, 1966), trade-off theory (Brennan and Schwartz 1978; Leland
1994; Brennan and Schwartz 1984; Kane et al. 1984), and modern Brusov
FilatovaOrekhova theory of capital cost and capital structure (Brusov and Filatova
2011; Brusov et al. 2011a, b, c, 2012a, b, 2013a, b, 2014a, b; Filatova et al. 2008).
The Traditional Approach The traditional (empirical) approach told businessmen
that weighted average cost of capital, WACC, and the associated company capitaliza-
tion, V CF=WACC, depend on the capital structure, the level of leverage. Debt cost
always turns out to be lower, than equity cost, because first one has lower risk, because
in the event of bankruptcy, creditor claims are met prior to shareholders claims.
As a result, an increase in the proportion of lower-cost debt capital in the overall
capital structure up to the limit, which does not cause violation of financial
sustainability and growth in risk of bankruptcy, leads to lower weighted average
cost of capital, WACC.
The profitability required by investors (the equity cost) is growing; however, its
growth has not led to compensation of benefits from the use of lower-cost debt
capital. Therefore, the traditional approach welcomes the increased leverage L D=S
and the associated increase of company capitalization. The traditional (empirical)
approach has existed up to appearance of the first quantitative theory by Modigliani
and Miller (1958).
ModiglianiMiller Theory Modigliani and Miller () in their first paper (with-
out taxes) (Modigliani and Miller 1958) have come to the conclusion (based on
assumptions that there are no taxes, no transaction costs, no bankruptcy costs, that
perfect market exists with symmetric information, that there is equivalence in
borrowing costs for both companies and investors, etc.) that the choosing of propor-
tion of debt and equity does not affect WACC and company value as well (Fig. 2.2).
4.1 Optimal Capital Structure of the Company 49
Most of Modigliani and Miller assumptions (Modigliani and Miller 1958), of

course, are unrealistic. Some assumptions can be removed without changing the
conclusions of the model. However, assuming no costs of bankruptcy and the absence
of taxes (or the presence of only corporate taxes) are crucialthe change of these
assumptions alters conclusions. The last two assumptions rule out the possibility of
signaling and agency costs theories and, thus, also constitute a critical prerequisite.
ModiglianiMiller theory with taxes (see Chap. 2) leads to conclusion that in
accordance with formula obtained by them,
WACC k0 1 wd T ; 4:1
weighted average cost of capital WA decreases continuously (Fig. 2.3) (WACC

decreases from k0 (at L 0) up to k0 1 T (at L 1), when the company is
financed entirely with borrowed funds). So, there is no optimal capital structure
within this theory. Below we modify ModiglianiMiller theory with taxes by taking
off the suggestion about riskless of debt capital, modeling the growth of risk of
bankruptcy by increase of credit rate, and show that optimal capital structure of the
company is still absent.
Trade-off Theory Reduction in financial sustainability of companies and increase
of bankruptcy risk, which relate to the use of different forms of borrowing in the
formation of financial capital structure of the company, are increased with the
increasing of debt.
ModiglianiMiller theory did not take into account the bankruptcy risk and
related costs. From its version with the tax on profit, it follows that debt financing
brings only some benefits associated with tax benefits (tax shield). Since company
capitalization grows with leverage level and there is no compensating increase in
the debt cost, increasing of the capitalization requires only the use of debt financing.
This obvious contradiction with the real economy has created many theories,
which had tried to find a balance between the advantages and disadvantages of
using debt financing by the companies. The advantage is a reduction of weighted
average cost of capital, WACC, and the corresponding increase of capitalization of
the companies, V, and the drawback is that the increase of debt financing reduces
the financial sustainability of the companies and increases the financial distress and
risk of bankruptcy.
One of these theories is trade-off theory (Brennan and Schwartz 1978; Leland
1994). There are two versions of this theory: static and dynamic. Former one is
based on the fact that at the low leverage level, the benefits of debt financing are
manifested: when WACC drops with leverage, a companys capitalization grows.
Starting with a certain leverage level, financial distress costs and risk of bank-
ruptcy are growing, the WACC begins to grow, and the value of the company
begins to fall. The leverage level, at which the value of tax benefits is approximately
equal to the cost of bankruptcy, determines the optimal (objective) capital structure.
While the static trade-off theory is a single-period model (Brennan and Schwartz
1978; Leland 1994), in the dynamic trade-off theory (Brennan and Schwartz 1984),
the financing decision depends on what the company anticipates in the next periods,
and which will be a capital structure.
4.2 Absence of the Optimal Capital Structure in Modified

ModiglianiMiller Theory (MMM Theory)
Let us show first that in ModiglianiMiller theory (odigliani and iller 1958,
1963), modified by us by taking off the suggestion about risklessness of debt
capital, the optimal capital structure is still absent.
Consider the case of arbitrary dependence of debt cost on leverage f(L ).
Suppose that debt cost kd is described by the following function:

kd0 const; at L L0
kd ; 4:2
kd0 f L; at L > L0
here f(L ) is arbitrary (growing or decreasing) function of leverage level L. We are

interested in leverage levels L > L0 , because at L < L0 , the standard Modigliani
Miller theory works and weighted average cost of capital, WACC, is decreased with
leverage
WACC k0 1 wd t ; 4:3
while an equity cost grows linearly with leverage
ke k0 Lk0 kd 1 t; 4:4
here ke is an equity cost; k0 is an equity cost of financially independent company; kd

is debt cost; t is tax on profit rate; and WACC is a weighted average cost of capital.
In this case, for WACC, one has
1 L
WACC ke we kd wd 1 t ke kd 1 t
1L 1L 4:5
1
ke kd L1 t:
1L
Substituting Eqs. (4.2) and (4.4) into (4.5), one has finally for weighted average cost
of capital, WACC,
1
WACC k0 Lk0 kd 1 t
1L
1
Lkd 1 t k0 k0 L1 t 4:6
1L
k0 1 L1 t
k0 we wd 1 t k0 1 wd t:
1L
One can see that weighted average cost of capital, WACC, does not depend on f(L).
Moreover, it is described by the same expression (Eq. 4.3), as in the case of riskless
debt capital. Note that the obtained result is consistent with the conclusions of
Rubinstein (1973) and Stiglitz (1969) that company value within ModiglianiMiller
4.3 Analysis of the Trade-Off Theory Within the BrusovFilatovaOrekhova Theory 51
theory is not changed upon the introduction of riskiness of debt capital. In our
approximation, as well as at Hsia (1981), debt cost is not already constant.
For derivative from weighted average cost of capital, WACC, on leverage level,
one has
0 1 t1 L 1 L1 t t
WACCL k0 2
k0 < 0: 4:7
1 L 1 L2
We have proved the following theorem:

In modified ModiglianiMiller theory (allowing riskiness debt capital) under
arbitrary change of debt cost with leverage (growing, as well as decreasing)
weighted average cost of capital, WACC, always falls down with leverage. This
means the absence of the companys optimal capital structure and proves insol-
vency of the well-known classical trade-off theory in its original formulation.
4.3 Analysis of the Trade-Off Theory Within

the BrusovFilatovaOrekhova Theory
Modigliani and Miller (1958, 1963, 1966) assumed that all financial flows are
perpetuity. Because, in reality, the lifetime of the companies is always, of course,
finite, this condition is one of the weaknesses of the Modigliani and Miller theory.
Account of the finite lifetime of the companies changes all the formulas of Modi-
gliani and Miller drastically. The solution of the problem of weighted average cost
of capital, WACC, for the companies with arbitrary lifetime has been done for the
first time by BrusovFilatovaOrekhova with coauthors (Brusov and Filatova 2011;
Brusov et al. 2011a, b, c, 2012a, b, 2013a, b, 2014a, b; Filatova et al. 2008; Brusova
2011). Their theory has allowed to find hidden global causes of the global financial
crisis (Brusov et al. 2012b) (see Chap. 6 for details).
The main formula, received by them, is an algebraic equation of n + 1 power
(here n is the lifetime of company) to calculate weighted average cost of capital,
WACC, taking the form
1 1 WACCn 1 1 k0 n
: 4:8
For n > 3, this equation can be solved numerically only. It is easy to use for this a
function matching parameters in the Excel.
Using Eq. (4.8), let us investigate the optimal capital structure in the trade-off
theory.
We are modeling the emergence of a financial volatility and of bankruptcy risk
by the growth of the cost of debt capital, kd, indicating that kd becomes risky, and its
growth represents a fee for the state of financial volatility and bankruptcy risk.
It is impossible to study such effects, as the growth of credit rate with leverage in
the theory of Modigliani and Miller (MM), because:
MM theory considers two types of assets: risky equity capital and free of risk
debt capital;
weighted average cost of capital, WACC, in the theory of Modigliani and Miller
is determined by the following expression (Eq. 4.3), which depends on k0, wd, T
and does NOT depend on kd. This is due to the fact that discounted value of tax
shield for an infinite period of time,
X
1 t
PVTS kd DT 1kd DT 4:9
t1
with the use of kd as discount rate does NOT depend on kd.

In contrast to the theory of the Modigliani and Miller, in a modern theory of
capital cost and capital structure of the company by BrusovFilatovaOrekhova
(Brusov and Filatova 2011; Brusov et al. 2011a, b, c, 2012a, b, 2013a, b, 2014a, b;
Filatova et al. 2008), discounted value of tax shield is valuated for finite period of
time n [lifetime of company or the time from the establishment of company up to
the present moment (n)] and depends on kd
X
n t
PVTS kd DT 1kd DT 1 1 kd n : 4:10
t1
Capitalization of a financially independent company is equal to
V 0 CF1 1 k0 n =k0 4:11
and capitalization of a financially dependent company is equal to
V CF1 1 WACCn =WACC: 4:12
As a result, for weighted average cost of capital WACC, the formula BFO is derived
1 1 WACCn 1 1 k0 n
4:13
and WACC now depends on kd

We consider linear and quadratic growth of debt cost kd with leverage, starting
from some value (with different coefficients), different values of k0 and different
lifetime n of the companies. Let us find WACC values.
1. n 3; t 20 %; L 0, 1, 2, . . . , 10

0:07; at L 2
k0 24 %; kd : 4:14
0:07 0:01L 22 ; at L > 2
See Table 4.1.
Table 4.1 Dependence of WACC on L

n L 0 1 2 3 4 5 6 7 8 9 10
3 kd 0.07 0.07 0.07 0.08 0.11 0.16 0.23 0.32 0.43 0.56 0.71
k0 A 1.9813 2.0184 2.0311 2.0445 2.0703 2.1075 2.1520 2.1988 2.2438 2.2842 2.3186
0.24 WACC 0.2401 0.2279 0.2238 0.2195 0.2111 0.1997 0.1864 0.1730 0.1605 0.1496 0.1406
WACC(L)
0.3000
0.2500
0.2000
0.1500
0.1000
0.0500
0.0000
0 1 2 3 4 5 6 7 8 9 10 11
Fig. 4.1 Dependence of WACC on L
2. n 5; t 20 %; L 0, 1, 2, . . . , 10

0:07; at L 2
k0 24 %; kd : 4:15
0:07 0:01L 22 ; at L > 2
See Table 4.2.

n L 0 1 2 3 4 5 6 7 8 9 10
5 kd 0.07 0.07 0.07 0.08 0.11 0.16 0.23 0.32 0.43 0.56 0.71
k0 A 2.7454 2.8265 2.8546 2.8835 2.9364 3.0080 3.0866 3.1605 3.2225 3.2703 3.3052
0.24 WACC 0.2400 0.2261 0.2215 0.2168 0.2083 0.1973 0.1858 0.1753 0.1669 0.1605 0.1560
WACC(L)
0.3000
0.2500
0.2000
0.1500
0.1000
0.0500
0.0000
0 1 2 3 4 5 6 7 8 9 10 11
3. n 3; t 20 %; L 0, 1, 2, . . . , 10

0:07; at L 2
k0 24 %; kd : 4:16
0:07 0:1L 22 ; at L > 2
See Table 4.3.

n L 0 1 2 3 4 5 6 7 8 9 10
3 kd 0.07 0.07 0.07 0.17 0.47 0.97 1.67 2.57 3.67 4.97 6.47
k0 A 1.9813 2.0184 2.0311 2.0996 2.2253 2.3170 2.3655 2.3904 2.4046 2.4137 2.4203
0.24 WACC 0.2401 0.2279 0.2238 0.2021 0.1656 0.1410 0.1289 0.1228 0.1193 0.1171 0.1156
WACC(L)
0.3000
0.2500
0.2000
0.1500
0.1000
0.0500
0.0000
0 1 2 3 4 5 6 7 8 9 10 11

4. n 5; t 20 %; L 0, 1, 2, . . . , 10

0:07; at L 2
k0 24 %; kd 2 : 4:17
0:07 0:1L 2 ; at L > 2
See Table 4.4.

n L 0 1 2 3 4 5 6 7 8 9 10
5 kd 0.07 0.07 0.07 0.17 0.47 0.97 1.67 2.57 3.67 4.97 6.47
k0 A 2.7454 2.8265 2.8546 2.9893 3.1801 3.2724 3.3084 3.3265 3.3387 3.3479 3.3554
0.24 WACC 0.2400 0.2261 0.2215 0.2001 0.1726 0.1603 0.1556 0.1533 0.1517 0.1506 0.1496
WACC(L)
0.3000
0.2500
0.2000
0.1500
0.1000
0.0500
0.0000
0 1 2 3 4 5 6 7 8 9 10 11
5. n 3; t 20 %; L 0, 1, 2, . . . , 10

0:07; at L 2
k0 24 %; kd : 4:18
0:07 0:01L 2; at L > 2
See Table 4.5.

n L 0 1 2 3 4 5 6 7 8 9 10
3 kd 0.07 0.07 0.07 0.08 0.09 0.1 0.11 0.12 0.13 0.14 0.15
k0 A 1.9813 2.0184 2.0311 2.0445 2.0563 2.0670 2.0770 2.0865 2.0957 2.1044 2.1129
0.24 WACC 0.2401 0.2279 0.2238 0.2195 0.2159 0.2122 0.2090 0.2061 0.2033 0.2006 0.1981
WACC(L)
0.3000
0.2500
0.2000
0.1500
0.1000
0.0500
0.0000
0 1 2 3 4 5 6 7 8 9 10 11
6. n 5; t 20 %; L 0, 1, 2, . . . , 10

0:07; at L 2
k0 24 %; kd : 4:19
0:07 0:01L 2; at L > 2
See Table 4.6.

n L 0 1 2 3 4 5 6 7 8 9 10
5 kd 0.07 0.07 0.07 0.08 0.09 0.1 0.11 0.12 0.13 0.14 0.15
k0 A 2.7454 2.8265 2.8546 2.8835 2.9083 2.9305 2.9511 2.9702 2.9883 3.0054 3.0216
0.24 WACC 0.2400 0.2261 0.2215 0.2168 0.2128 0.2093 0.2060 0.2031 0.2003 0.1977 0.1952
WACC(L)
0.3000
0.2500
0.2000
0.1500
0.1000
0.0500
0.0000
0 1 2 3 4 5 6 7 8 9 10 11

7. n 3; t 20 %; L 0, 1, 2, . . . , 10

0:07; at L 2
k0 24 %; kd : 4:20
0:07 0:1L 2; at L > 2
See Table 4.7.

n L 0 1 2 3 4 5 6 7 8 9 10
3 kd 0.07 0.07 0.07 0.17 0.27 0.37 0.47 0.57 0.67 0.77 0.87
k0 A 1.9813 2.0184 2.0311 2.0996 2.1580 2.2060 2.2450 2.2768 2.3028 2.3242 2.3420
0.24 WACC 0.2401 0.2279 0.2238 0.2021 0.1847 0.1710 0.1602 0.1516 0.1447 0.1391 0.1346
WACC(L)
0.3000
0.2500
0.2000
0.1500
0.1000
0.0500
0.0000
0 1 2 3 4 5 6 7 8 9 10 11
8. n 5; t 20 %; L 0, 1, 2, . . . , 10

0:07; at L 2
k0 24 %; kd : 4:21
0:07 0:1L 2; at L > 2
See Table 4.8.

n L 0 1 2 3 4 5 6 7 8 9 10
5 kd 0.07 0.07 0.07 0.17 0.27 0.37 0.47 0.57 0.67 0.77 0.87
k0 A 2.7454 2.8265 2.8546 2.9893 3.0902 3.1634 3.2164 3.2553 3.2843 3.3063 3.3232
0.24 WACC 0.2400 0.2261 0.2215 0.2001 0.1853 0.1749 0.1677 0.1625 0.1587 0.1559 0.1537
WACC(L)
0.3000
0.2500
0.2000
0.1500
0.1000
0.0500
0.0000
0 1 2 3 4 5 6 7 8 9 10 11
9. n 3; t 20 %; L 0, 1, 2, . . . , 10

0:07; at L 2
k0 12 %; kd : 4:22
0:07 0:01L 22 ; at L > 2
See Table 4.9.

n L 0 1 2 3 4 5 6 7 8 9 10
3 kd 0.07 0.07 0.07 0.08 0.11 0.16 0.23 0.32 0.43 0.56 0.71
k0 A 2.4018 2.4468 2.4621 2.4785 2.5098 2.5548 2.6087 2.6655 2.7200 2.7690 2.8107
0.12 WACC 0.1200 0.1093 0.1057 0.1019 0.0948 0.0849 0.0734 0.0615 0.0506 0.0412 0.0333
WACC(L)
0.1400
0.1200
0.1000
0.0800
0.0600
0.0400
0.0200
0.0000
0 1 2 3 4 5 6 7 8 9 10 11

10. n 5; t 20 %; L 0, 1, 2, . . . , 10

0:07; at L 2
k0 12 %; kd 2 : 4:23
0:07 0:01L 2 ; at L > 2
See Table 4.10.

n L 0 1 2 3 4 5 6 7 8 9 10
5 kd 0.07 0.07 0.07 0.08 0.11 0.16 0.23 0.32 0.43 0.56 0.71
k0 A 3.6048 3.7113 3.7482 3.7862 3.8556 3.9496 4.0528 4.1498 4.2312 4.2940 4.3399
0.12 WACC 0.1200 0.1084 0.1045 0.1005 0.0934 0.0841 0.0744 0.0655 0.0584 0.0530 0.0492
WACC(L)
0.1400
0.1200
0.1000
0.0800
0.0600
0.0400
0.0200
0.0000
0 1 2 3 4 5 6 7 8 9 10 11
11. n 3; t 20 %; L 0, 1, 2, . . . , 10

0:07; at L 2
k0 12 %; kd : 4:24
0:07 0:1L 22 ; at L > 2
See Table 4.11.

n L 0 1 2 3 4 5 6 7 8 9 10
3 kd 0.07 0.07 0.07 0.17 0.47 0.97 1.67 2.57 3.67 4.97 6.47
k0 A 2.4018 2.4468 2.4621 2.5452 2.6976 2.8087 2.8676 2.8978 2.9150 2.9260 2.9340
0.12 WACC 0.1200 0.1093 0.1057 0.0870 0.0551 0.0337 0.0230 0.0176 0.0146 0.0127 0.0113
WACC(L)
0.1400
0.1200
0.1000
0.0800
0.0600
0.0400
0.0200
0.0000
0 1 2 3 4 5 6 7 8 9 10 11
12. n 5; t 20 %; L 0, 1, 2, . . . , 10

0:07; at L 2
k0 12 %; kd : 4:25
0:07 0:1L 22 ; at L > 2
See Table 4.12.

n L 0 1 2 3 4 5 6 7 8 9 10
5 kd 0.07 0.07 0.07 0.17 0.47 0.97 1.67 2.57 3.67 4.97 6.47
k0 A 3.6048 3.7113 3.7482 3.9250 4.1755 4.2968 4.3440 4.3678 4.3838 4.3959 4.4058
0.12 WACC 0.1200 0.1084 0.1045 0.0866 0.0633 0.0528 0.0489 0.0468 0.0455 0.0445 0.0437
WACC(L)
0.1400
0.1200
0.1000
0.0800
0.0600
0.0400
0.0200
0.0000
0 1 2 3 4 5 6 7 8 9 10 11

4.4 The Causes of Absence of the Optimum Capital Structure in Trade-Off Theory 61
One can see (Figs. 4.1, 4.2, 4.3, 4.4, 4.5, 4.6, 4.7, 4.8, 4.9, 4.10, 4.11, and 4.12)
that WACC(L ) is monotonically diminishing function. In spite of the fact that the
rise in the cost of debt financing was assumed, and fairly significant, WACC is not
growing with leverage.
In dependence of WACC(L ), a cupped zone (in the mathematical sense, WAC
00
CL2 < 0) appears only, which more or less corresponds to the leverage level, at
which the increase in the cost of debt capital begins (in our case, L 2).
Note that distortion of the WACC(L ) dependence is mostly determined by the
function kd(L ) (linear or quadratic ) and by the factors at L 2 or L 22 . Linear
dependence of kd(L) distorts the WACC(L ) dependence less than square one, as
well as the smaller factor (0.01).
The change of the companys lifetime (from 3 to 5 years) has a smaller effect,
although a bigger lifetime may lead to more substantial changes in WACC(L)
dependence. The reduction of a difference k0 kd between k0 and kd leads to an
increase of effect.
The main conclusion that can be drawn from the obtained results is the follow-
ing: the optimal capital structure in well-known trade-off theory is missing,
contrary to hopes and expectations of its creators and supporters.
The question immediately appears: why this turned out to be possible, and how
this can be? How can the weighted average cost of capital
WACC we ke wd kd 1 T ; 4:26
not grow if both kd and ke are growing? (ke is growing with leverage in accordance
to (Eq. 4.4), and kd is growing in accordance to our assumption).
The answer will be received in the next paragraph, where we are investigating
the dependence of equity cost ke on leverage L with the same assumptions about the
risk of debt capital and growth, as a consequence, of its cost with the leverage.
4.4 The Causes of Absence of the Optimum Capital

Structure in Trade-Off Theory
So, we will investigate the dependence of the equity cost ke on leverage L with the
same assumptions about the risk of the debt and growth of its cost with leverage.
In the ModiglianiMiller theory, equity cost ke always grows with leverage, as
well as in BrusovFilatovaOrekhova theory. In the latter one, however, an abnor-
mal effect, discovered by us, exists (Brusov et al. 2013a, b): decreasing of equity
cost ke with leverage L. This effect, which is absent in perpetuity ModiglianiMiller
limit, takes place under account of finite lifetime of the company at tax on profits
rate, which exceeds some value T*. At some ratios between debt cost and equity
capital cost, the discovered effect takes place at tax on profit rate, existing in
western countries and Russia. But this effect has been obtained under condition
of a constant debt cost kd. Let us see, how the growth of debt cost kd with leverage
affects the equity costs ke dependence on leverage. We will consider the same
cases as above for the calculations of dependences of WACC(L ).
1. n 3; t 20 %; L 0, 1, 2, . . . , 10

0:07; at L 2
k0 24 %; kd : 4:27
0:07 0:01L 22 ; at L > 2
See Table 4.13.
Table 4.13 Dependence of equity cost ke on L

n L 0 1 2 3 4 5 6 7 8 9 10
3 kd 0.07 0.07 0.07 0.08 0.11 0.16 0.23 0.32 0.43 0.56 0.71
k0 A 1.9813 2.0184 2.0311 2.0445 2.0703 2.1075 2.1520 2.1988 2.2438 2.2842 2.3186
0.24 ke 0.2401 0.3997 0.5594 0.6861 0.7036 0.5581 0.2011 0.4081 1.3075 2.5356 4.133
Ke(L)
0.8000
0.7000
0.6000
0.5000
0.4000
0.3000
0.2000
0.1000
0.0000
0 1 2 3 4 5 6 7
Fig. 4.13 Dependence of equity cost ke on L
2. n 5; t 20 %; L 0, 1, 2, . . . , 10

0:07; at L 2
k0 24 %; kd 2 : 4:28
0:07 0:01L 2 ; at L > 2
See Table 4.14.

n L 0 1 2 3 4 5 6 7 8 9 10
5 kd 0.07 0.07 0.07 0.08 0.11 0.16 0.23 0.32 0.43 0.56 0.71
k0 A 2.7454 2.8265 2.8546 2.8835 2.9364 3.0080 3.0866 3.1605 3.2225 3.2703 3.3052
0.24 ke 0.2400 0.3962 0.5524 0.6750 0.6897 0.5438 0.1966 0.3892 1.2501 2.4267 3.964
Ke(L)
0.8000
0.7000
0.6000
0.5000
0.4000
0.3000
0.2000
0.1000
0.0000
0 1 2 3 4 5 6 7
3. n 3; t 20 %; L 0, 1, 2, . . . , 10

0:07; at L 2
k0 24 %; kd : 4:29
0:07 0:1L 22 ; at L > 2
See Table 4.15.

n L 0 1 2 3 4 5 6 7 8 9 10
3 kd 0.07 0.07 0.07 0.17 0.47 0.97 1.67 2.57 3.67 4.97 6.47
k0 A 1.9813 2.0184 2.0311 2.0996 2.2253 2.3170 2.3655 2.3904 2.4046 2.4137 2.4203
0.24 ke 0.2401 0.3997 0.5594 0.4003 0.6760 3.0339 7.1136 13.4098 22.4140 34.6126 50.489
Ke(L)
0.8000
0.6000
0.4000
0.2000
0.0000
0 1 2 3 4 5
-0.2000
-0.4000
-0.6000
-0.8000

4. n 5; t 20 %; L 0, 1, 2, . . . , 10

0:07; at L 2
k0 24 %; kd 2 : 4:30
0:07 0:1L 2 ; at L > 2
See Table 4.16.

n L 0 1 2 3 4 5 6 7 8 9 10
5 kd 0.07 0.07 0.07 0.17 0.47 0.97 1.67 2.57 3.67 4.97 6.47
k0 A 2.7454 2.8265 2.8546 2.9893 3.1801 3.2724 3.3084 3.3265 3.3387 3.3479 3.3554
0.24 ke 0.2400 0.3962 0.5524 0.3926 0.6408 2.9184 6.9268 13.1658 22.1224 34.2784 50.114
Ke(L)
0.8000
0.6000
0.4000
0.2000
0.0000
0 1 2 3 4 5
-0.2000
-0.4000
-0.6000
-0.8000
5. n 3; t 20 %; L 0, 1, 2, . . . , 10

0:07; at L 2
k0 24 %; kd : 4:31
0:07 0:01L 2; at L > 2
See Table 4.17.

n L 0 1 2 3 4 5 6 7 8 9 10
3 kd 0.07 0.07 0.07 0.08 0.09 0.1 0.11 0.12 0.13 0.14 0.15
k0 A 1.9813 2.0184 2.0311 2.0445 2.0563 2.0670 2.0770 2.0865 2.0957 2.1044 2.1129
0.24 ke 0.2401 0.3997 0.5594 0.6861 0.7913 0.8730 0.9353 0.9767 0.9976 0.9982 0.9787
Ke(L)
0.8000
0.7000
0.6000
0.5000
0.4000
0.3000
0.2000
0.1000
0.0000
0 1 2 3 4 5 6 7
6. n 5; t 20 %; L 0, 1, 2, . . . , 10

0:07; at L 2
k0 24 %; kd : 4:32
0:07 0:01L 2; at L > 2
See Table 4.18.

n L 0 1 2 3 4 5 6 7 8 9 10
5 kd 0.07 0.07 0.07 0.08 0.09 0.1 0.11 0.12 0.13 0.14 0.15
k0 A 2.7454 2.8265 2.8546 2.8835 2.9083 2.9305 2.9511 2.9702 2.9883 3.0054 3.0216
0.24 ke 0.2400 0.3962 0.5524 0.6750 0.7759 0.8555 0.9143 0.9525 0.9706 0.9689 0.9477
Ke(L)
1.2000
1.0000
0.8000
0.6000
0.4000
0.2000
0.0000
0 1 2 3 4 5 6 7 8 9 10 11

7. n 3; t 20 %; L 0, 1, 2, . . . , 10

0:07; at L 2
k0 24 %; kd : 4:33
0:07 0:1L 2; at L > 2
See Table 4.19.

n L 0 1 2 3 4 5 6 7 8 9 10
3 kd 0.07 0.07 0.07 0.17 0.27 0.37 0.47 0.57 0.67 0.77 0.87
k0 A 1.9813 2.0184 2.0311 2.0996 2.1580 2.2060 2.2450 2.2768 2.3028 2.3242 2.3420
0.24 ke 0.2401 0.3997 0.5594 0.4003 0.0594 0.4542 1.1348 1.9792 2.9855 4.1526 5.48
Ke(L)
0.6000
0.5000
0.4000
0.3000
0.2000
0.1000
0.0000
0 1 2 3 4 5
8. n 5; t 20 %; L 0, 1, 2, . . . , 10

0:07; at L 2
k0 24 %; kd : 4:34
0:07 0:1L 2; at L > 2
See Table 4.20.

n L 0 1 2 3 4 5 6 7 8 9 10
5 kd 0.07 0.07 0.07 0.17 0.27 0.37 0.47 0.57 0.67 0.77 0.87
k0 A 2.7454 2.8265 2.8546 2.9893 3.0902 3.1634 3.2164 3.2553 3.2843 3.3063 3.3232
0.24 ke 0.2400 0.3962 0.5524 0.3926 0.0624 0.4304 1.0822 1.8920 2.8596 3.9853 5.269
Ke(L)
0.6000
0.5000
0.4000
0.3000
0.2000
0.1000
0.0000
0 1 2 3 4 5
9. n 3; t 20 %; L 0, 1, 2, . . . , 10

0:07; at L 2
k0 12 %; kd : 4:35
0:07 0:01L 22 ; at L > 2
See Table 4.21.

n L 0 1 2 3 4 5 6 7 8 9 10
3 kd 0.07 0.07 0.07 0.08 0.11 0.16 0.23 0.32 0.43 0.56 0.71
k0 A 2.4018 2.4468 2.4621 2.4785 2.5098 2.5548 2.6087 2.6655 2.7200 2.7690 2.8107
0.12 ke 0.1200 0.1626 0.2051 0.2157 0.1222 0.1307 0.5904 1.2998 2.2963 3.6202 5.313
Ke(L)
0.8000
0.7000
0.6000
0.5000
0.4000
0.3000
0.2000
0.1000
0.0000
0 1 2 3 4 5 6 7

10. n 5; t 20 %; L 0, 1, 2, . . . , 10

0:07; at L 2
k0 12 %; kd 2 : 4:36
0:07 0:01L 2 ; at L > 2
See Table 4.22.

n L 0 1 2 3 4 5 6 7 8 9 10
5 kd 0.07 0.07 0.07 0.08 0.11 0.16 0.23 0.32 0.43 0.56 0.71
k0 A 3.6048 3.7113 3.7482 3.7862 3.8556 3.9496 4.0528 4.1498 4.2312 4.2940 4.3399
0.12 ke 0.1200 0.1607 0.2014 0.2100 0.1152 0.1352 0.5829 1.2677 2.2267 3.5020 5.139
Ke(L)
0.2500
0.2000
0.1500
0.1000
0.0500
0.0000
0 1 2 3 4 5
11. n 3; t 20 %; L 0, 1, 2, . . . , 10

0:07; at L 2
k0 12 %; kd : 4:37
0:07 0:1L 22 ; at L > 2
See Table 4.23.

n L 0 1 2 3 4 5 6 7 8 9 10
3 kd 0.07 0.07 0.07 0.17 0.47 0.97 1.67 2.57 3.67 4.97 6.47
k0 A 2.4018 2.4468 2.4621 2.5452 2.6976 2.8087 2.8676 2.8978 2.9150 2.9260 2.9340
0.12 ke 0.1200 0.1626 0.2051 0.0601 1.2286 3.6778 7.8553 14.2512 23.3566 35.6572 51.636
Ke(L)
0.4000
0.2000
0.0000
0 1 2 3 4 5
-0.2000
-0.4000
-0.6000
-0.8000
-1.0000
-1.2000
-1.4000
12. n 5; t 20 %; L 0, 1, 2, . . . , 10

0:07; at L 2
k0 12 %; kd : 4:38
0:07 0:1L 22 ; at L > 2
See Table 4.24.

n L 0 1 2 3 4 5 6 7 8 9 10
5 kd 0.07 0.07 0.07 0.17 0.47 0.97 1.67 2.57 3.67 4.97 6.47
k0 A 3.6048 3.7113 3.7482 3.9250 4.1755 4.2968 4.3440 4.3678 4.3838 4.3959 4.4058
0.12 ke 0.1200 0.1607 0.2014 0.0615 1.1876 3.5634 7.6740 14.0175 23.0784 35.3389 51.279
Ke(L)
0.4000
0.2000
0.0000
-0.2000 0 1 2 3 4 5
-0.4000
-0.6000
-0.8000
-1.0000
-1.2000
-1.4000

An analysis of the obtained results (Figs. 4.13, 4.14, 4.15, 4.16, 4.17, 4.18, 4.19,
4.20, 4.21, 4.22, 4.23, and 4.24) leads to the following conclusions.
Under the turning on the growth of debt cost kd with leverage, the dependence of
equity cost ke on leverage is undergoing significant changes. The linear growth of
equity cost ke at low leverage level is changed by its fall, starting with some value
L0. The L0 value sometimes exactly correlates with the starting point of kd growth
with leverage (L0 2) but sometimes takes values which are significantly higher
(up to L0 8:5).
The speed of decreasing of equity cost ke with leverage increases with increasing
of growth factor of debt cost kd as well as under the transition to quadratic growth.
This is especially noticeable in the case 6, where there is a ke growth, up to the
leverage level L 8.5.
So, we come to the conclusion that the increase in the cost of debt capital kd with
leverage leads to the decrease of equity cost ke with leverage, starting with some
value L0. This is the cause of the absence of weighted average capital cost
growth with leverage at all its values.
Note that the results remain qualitatively the same, if one uses different depen-
dences of kd on leverage. For example, for the case of exponential growth of kd with
leverage
n 5; t 20 %; L 0, 1, 2, . . . , 6;

0:12; at L 1
k0 22 %; kd 4:39
0:12 0:01 3L1 ; at L > 1
one gets the following dependence of kd, kd, and WACC on leverage.
n=5
0.5
0.4 Kd
Kd
0.3 Wacc
0.2
Wacc Ke
0.1
Ke
0
0 2 4 6 8
L
Fig. 4.25 Dependence of equity cost ke, debt cost kd, and WACC on leverage L
So, the conclusions made are independent of rate of growth of kd with leverage.
Conclusion The analysis of well-known trade-off theory, conducted with the help
of modern theory of capital structure and capital cost by BrusovFilatova
Orekhova, has shown that the suggestion of risky debt financing (and growth of a
credit rate near the bankruptcy) in opposite to waiting result does not lead to the
References 71
growth of WACC, which still decreases with leverage. This means the absence of
minimum in the dependence of WACC on leverage as well as the absence of
maximum in the dependence of capitalization V on leverage. Thus, this means
that the optimal capital structure is absent in famous trade-off theory. The
explanation to this fact has been done within the same BrusovFilatovaOrekhova
theory by studying the dependence of the equity cost ke on leverage. It turned out
that the growth of debt cost kd with leverage led to the decrease of equity cost ke
with leverage, starting from some leverage level, which is higher than starting point
of debt cost growth. This paradox conclusion gives the explanation of the absence
of the optimal capital structure in the famous trade-off theory. This means that
competition of benefits from the use of debt financing and of financial distress cost
(or a bankruptcy cost) are NOT balanced, and the hope that trade-off theory gives us
the optimal capital structure, unfortunately, is not realized.
The absence of the optimal capital structure in the trade-off theory questioned
the existence of an optimal capital structure of the company at all [but as authors
have shown, the optimal capital structure in the investments still exists (Brusov
et al. 2011b)]. In the search for the golden fleece, one needs to switch to study of
other mechanisms for formation of the optimal capital structure of the company,
different from ones considered in trade-off theory. And one of such mechanisms has
been discovered by us (see Chap. 5 for details).
References
Baker M, Wurgler J (2002) Market timing and capital structure. J Financ 57(1):132
Bikhchandani S, Hirshleifer D, Welch I (1998) Learning from the behavior of others: conformity,
fads, and informational cascades. J Econ Perspect 12(3):151170
Brennan M, Schwartz E (1978) Corporate income taxes, valuation, and the problem of optimal
capital structure. J Bus 51:103114
Brennan M, Schwartz E (1984) Optimal financial policy and firm valuation. J Financ 39:593607
capital structure of the company. Finance Credit 3(435):28
(11):815824
2:1621

http://dx.doi.org/10.1080/23322039.2014.946150
Dittmar A, Thakor A (2007) Why do firms issue equity? J Financ 62(1):154
Fama E, French K (2004) Financing decisions: who issues stock? Working Paper
Filbeck G, Raymond F, Preece D (1996) Behavioral aspects of the intra-industry capital structure
decision. J Financ Strat Decis 9(2):5566
Graham J, Harvey C (2001) The theory and practice of corporate finance: evidence from the field. J
Financ Econ 60:187243
Hovakimian A, Opler T, Titman S (2001) The debt-equity choice. J Financ Quant Anal 36(1):124
Hsia (1981) Coherence of the modern theories of finance. Financ Rev 16(1):2742
Jenter D (2005) Market timing and managerial portfolio decisions. J Financ 60(4):19031949
Kane A, Marcus A, McDonald R (1984) How big is the tax advantage to debt? J Financ
39:841853
Leland H (1994) Corporate debt value, bond covenants, and optimal capital structure. J Financ 49
(4):12131252
Econ Rev 53:147175
19541957. Am Econ Rev 56:333391
Myers S (1984) The capital structure puzzle. J Financ 39(3):574592
Myers S, Majluf N (1984) Corporate financing and investment decisions when firms have
information that investors do not have. J Financ Econ 13:187221
Post J, Preston L, Sachs S (2002) Redefining the corporation: stakeholder management and
organizational wealth. Stanford University Press, Stanford
Rubinstein M (1973) A mean-variance synthesis of corporate financial theory. J Financ
28:167181
Stiglitz J (1969) A re-examination of the ModiglianiMiller theorem. Am Econ Rev 59
(5):784793
Chapter 5
New Mechanism of Formation
of the Companys Optimal Capital Structure,
Different from Suggested by Trade-Off
Theory
Under condition proved by us, insolvency of well-known classical trade-off theory

and question of finding new mechanisms of formation of the companys optimal
capital structure, different from the one suggested by trade-off theory, becomes
very important. One of the real such mechanisms is developed by us in this chapter.
It is based on the decrease of debt cost with leverage, which is determined by
growth of debt volume. This mechanism is absent in perpetuity ModiglianiMiller
theory, even in modified version, developed by us, and exists within more general
modern theory of capital cost and capital structure by BrusovFilatovaOrekhova
(BFO theory).
5.1 Absence of Suggested Mechanism of Formation

of the Companys Optimal Capital Structure Within
Modified ModiglianiMiller Theory (MMM Theory)
Analyzing the validity of well-known trade-off theory (Brennan and Schwartz

1978, 1984; Leland 1994), we have investigated the problem of existing optimal
capital structure of company within ModiglianiMiller theory (odigliani and
iller 1958, 1963, 1966), modified by us by taking off the suggestion about
risklessness of debt capital (MMM theory), as well as within modern theory of
capital cost and capital structure by BrusovFilatovaOrekhova (BFO theory)
applicable to companies with arbitrary lifetime and investment projects of arbitrary
duration (Brusov and Filatova 2011; Brusov et al. 2011a, b, c, 2012a, b, 2013a, b,
2014a, b; Filatova et al. 2008; Brusova 2011). Within both theories ( and
BFO), the absence of the optimal capital structure has been proved under the
modeling of financial distress and danger of bankruptcy by increase of debt cost.
This proves the insolvency of the classical trade-off theory (Brusov et al. 2013a),

DOI 10.1007/978-3-319-14732-1_5
74 5 New Mechanism of Formation of the Companys Optimal Capital. . .
which is based on the following suggestions (Brennan and Schwartz 1978, 1984;
Leland 1994):
At low leverage levels, the advantages of using debt financing (which is cheaper
than equity one) are connected to the fact that the weighted average cost of capital,
WACC, decreases with leverage and consequently the company capitalization
grows. Starting from some leverage level, financial distress appears and grows;
bankruptcy risk grows as well. The increase of WACC and consequently the
decrease of the companys capitalization start. The leverage level, at which profits
of debt capital using are approximately equal to the bankruptcy cost, determines the
companys optimal capital structure.
As our investigations show (Brusov et al. 2013a), within both theories, growth of
WACC and consequently decrease of the companys capitalization are absent. We
have given the explanation of such a phenomenon: for leverage levels above some
value L *, the equity cost decreases with leverage, providing continuous (at all
leverage levels) fall down of WACC.
The conclusion, made by us, is as follows: the mechanism of formation of the
companys optimal capital structure, suggested in the trade-off theory about
40 years ago, turns out to be insolvent (Brusov et al. 2013a). From the other side,
continuous and unlimited fall of weighted average cost of capital, WACC, and,
consequently, unlimited growth of the companys capitalization with leverage seem
to contradict the existing experience.
Willing to study the problem of the existing optimal capital structure of com-
pany, we investigate the influence of debt cost on equity cost and on weighted
average cost of capital, WACC. We have discovered the presence of correlations
between debt cost and equity cost, which could give another mechanism of forma-
tion of optimal capital structure of the company (different from the one suggested
by the trade-off theory) at leverage levels, which are far enough from the critical
levels, at which financial distress appears and the bankruptcy risk increases. The
detailed description of such a mechanism is the main purpose of this chapter.
Suggested mechanism of formation of the optimal capital structure of company
is based on the decrease of debt cost, which (in some range of leverage levels) is
determined by the growth of the debt volume.
As it has been shown in previous chapter, in modified ModiglianiMiller theory
(MMM theory) (allowing riskiness debt capital), under arbitrary change of debt cost
with leverage (growing as well as decreasing) weighted average cost of capital,
WACC, always falls with leverage. If one considers the growth of debt cost with
leverage, this means the absence of the optimal capital structure of company and
proves insolvency of well-known classical trade-off theory in its original formula-
tion. If one considers the decrease of debt cost with leverage, this means the absence
of suggested mechanism of formation of the companys optimal capital structure
within modified (by us) ModiglianiMiller theory. But, as it will be seen below,
situation turns out to be different in the modern theory of capital cost and capital
structure by BrusovFilatovaOrekhova (BFO theory).
5.2 Formation of the Companys Optimal Capital Structure Within Brusov-. . . 75
5.2 Formation of the Companys Optimal Capital

Structure Within BrusovFilatovaOrekhova (BFO)
Theory
The situation is different in the modern theory of capital cost and capital structure
by BrusovFilatovaOrekhova (BFO theory) (Brusov and Filatova 2011; Brusov
et al. 2011a, b, c, 2012a, b, 2013a, b, 2014a, b; Filatova et al. 2008). As it will be
shown below, the decrease of debt cost with leverage leads to the formation of
minimum in the dependence of WACC on leverage at moderate leverage levels (far
from the critical levels, at which financial distress appears and the bankruptcy
risk increases). Existence of such minimum leads to the appearance of maximum in
capitalization of the company. So, we suggest a new mechanism of formation of the
companys optimal capital structure, different from the one suggested by (already
insolvent) trade-off theory.
Before studying the problem within BFO theory (Brusov and Filatova 2011;
Brusov et al. 2011a, b, c, 2012a, b, 2013a, b, 2014a, b; Filatova et al. 2008), let us
consider 1-year companies, which have been studied by Myers (2001). This case is
the particular case of more general BFO theory.
For weighted average cost of capital, WACC, of 1-year company, one has
1 k0
WACC k0 kd wd t; 5:1
1 kd
here wd is the debt fraction.

The debt cost kd still has the following form:

kd0 const; at L L0
kd ; 5:2
kd0 f L; at L > L0
Thus, weighted average cost of capital, WACC, at leverage levels L > L0 is equal to
1 k0 L
WACC k0 kd0 f L t 5:3
1 kd0 f L 1L
and, obviously, depends on the form of f(L ). Thus, the difference of the simplest
case of 1-year companies from perpetuity ones, which, as we have shown above in
previous chapter, is independent of the form of f(L ), becomes obvious.
We will not analyze here 1-year companies in detail, but instead, we will go now
to analysis of companies with arbitrary lifetime (arbitrary age), described by BFO
theory (Brusov and Filatova 2011; Brusov et al. 2011a, b, c, 2012a, b, 2013a, b,
2014a, b; Filatova et al. 2008).
Let us consider a few types of dependences of debt cost on leverage f(L ).
Decrease of Debt Cost at Exponential Rate

We have the following parameters:
L0 1; k0 0:22; kd 0:12; t 0:2
and the debt cost has the form

kd0 const; at L L0 1
kd : 5:4
kd0 3LL0 ; at L > L0 1
Calculation of the weighted average cost of capital, WACC, will be done, using the
BFO formula
1 1 WACCn 1 1 k0 n
: 5:5
WACC L n
k0 1t 1 1 kd
1 L
By the function Matching parameter in Excel, we will find the weighted average
cost of capital, WACC, values.
Then, using obtained values of WACC, we will find the cost of equity values ke
by the formula:
WACC ke we kd wd 1 t
ke WACC1 L kd L1 t: 5:6
Formula (Eq. 5.6) is the definition of the weighted average cost of capital, WACC,
for the case of existing of taxing.
The application of BFO formula (Eq. 5.5) is very wide: authors have applied it in
corporate finance, in investments, in taxing, in business valuation, in banking, and
in some other areas (Brusov and Filatova 2011; Brusov et al. 2011a, b, c, 2012a, b,
2013a, b, 2014a, b; Filatova et al. 2008). Using this formula (Eq. 5.5), one can study
the dependence of the weighted average cost of capital, WACC, as well as the
equity cost ke on leverage level, L, on tax on profit rate, t, and on lifetime of the
company, n.
The Case 0:01 Let us consider first the case 0:01.
We will study below the dependence of debt cost, kd, equity cost, ke, and
weighted average cost of capital, WACC, on leverage level L in case of exponential
decrease of kd (Table 5.1 and Figs. 5.1, 5.2, 5.3, 5.4, 5.5, 5.6 and 5.7).
Table 5.1 kd, ke, and weighted average cost of capital, WACC, for companies with lifetimes
(ages) n 1, 3, 5, and 10
L 0 0.5 1 1.1 1.3 1.6 2 3 4
kd 0.12 0.12 0.12 0.1188 0.1161 0.1107 0.1 0.04 0.14
WACC 0.220 0.211 0.207 0.206 0.205 0.206 0.206 0.214 0.252
(n 1)
ke (n 1) 0.220 0.257 0.294 0.302 0.320 0.358 0.417 0.736 1.819
WACC 0.219 0.208 0.201 0.201 0.199 0.199 0.198 0.209 0.279
(n 3)
ke (n 3) 0.219 0.252 0.281 0.291 0.307 0.340 0.395 0.716 1.955
WACC 0.220 0.206 0.200 0.199 0.197 0.197 0.196 0.207 0.301
(n 5)
ke (n 5) 0.220 0.250 0.279 0.287 0.303 0.335 0.388 0.710 2.067
WACC 0.220 0.206 0.199 0.198 0.196 0.196 0.194 0.205 0.383
(n 10)
ke(n 10) 0.220 0.249 0.277 0.285 0.301 0.332 0.383 0.699 2.474

debt cost kd on leverage
level L in case of its
exponential decrease at
0:01

weighted average cost of
capital, WACC, on leverage
level L in case of
exponential decrease of
debt cost at 0:01

equity cost ke on leverage
level L in case of its
exponential decrease at
0:01

debt cost kd, equity cost ke,
of capital, WACC, on
leverage level L in case of
debt cost, kd, at 0:01 for
1-year company

debt cost kd, at 0:01 for
3-year company
Fig. 5.6 Dependence of n=5

debt cost kd, equity cost ke, 0.4
of capital, WACC, on 0.3 Ke
leverage level L in case of Wacc
exponential decrease of 0.2
5-year company 0.1
Kd
0
0 0.5 1 1.5 2 2.5 3 3.5
L
Fig. 5.7 Dependence of debt cost kd, equity cost ke, and weighted average cost of capital, WACC,
on leverage level L in case of exponential decrease of debt cost, kd, at 0:01 for 10-year
company
The Case 0:1 Let us consider now the case 0:1 (Table 5.2 and Figs. 5.8,
5.9, 5.10, 5.11, 5.12 and 5.13).
Table 5.2 Debt cost kd and weighted average cost of capital, WACC, for companies with
lifetimes n 1, 3, 5,and 10
L 0 0.5 0.7 1 1.1 1.3 1.5 2 4
kd 0.12 0.12 0.12 0.12 0.108 0.081 0.047 0.08 2.48
WACC 0.220 0.211 0.209 0.207 0.207 0.210 0.213 0.233 0.107
(n 1)
ke (n 1) 0.220 0.257 0.272 0.294 0.316 0.377 0.463 0.860 9.384
WACC 0.219 0.207 0.204 0.201 0.202 0.205 0.210 0.244 0.079
(n 3)
ke (n 3) 0.219 0.251 0.264 0.281 0.304 0.365 0.455 0.892 10.314
WACC 0.220 0.207 0.204 0.200 0.200 0.203 0.208 0.252 0.132
(n 5)
ke (n 5) 0.220 0.250 0.262 0.279 0.301 0.362 0.451 0.916 10.578
WACC 0.220 0.206 0.203 0.199 0.199 0.201 0.206 0.272 0.170
(n 10)
ke (n 10) 0.220 0.249 0.261 0.277 0.299 0.357 0.446 0.976 10.768

level L in case of
debt cost, kd, at 0:1

equity cost ke on leverage
level L in case of
debt cost, kd, at 0:1

1-year company

3-year company

5-year company

10-year company
Let us valuate the optimum position L* and its depth, WACC, using obtained
results (see Table 5.3).
Table 5.3 Optimum position L* and its depth WACC for lifetimes n 1, 3, 5, and 10
Optimum position L* Optimum depth WACC
n 1 3 5 10 1 3 5 10
0:01 1.3 2 2 2 1.7 % 2.2 % 2.4 % 2.6 %
0:1 11.1 1 11.1 11.1 1.5 % 2.1 % 2.2 % 2.3 %
The Quadratic Decrease of Debt Cost kd With Leverage Let us consider the
quadratic decrease of debt cost kd with leverage.
We will study below the dependence of debt cost kd, equity cost ke, and weighted
average cost of capital, WACC, on leverage level L in case of quadratic decrease of
kd..
We use the same parameters, as above
L0 1; k0 0:22; kd 0:12; t 0:2
with the following dependence of debt cost kd on leverage:

kd0 const; at L L0 1
kd 2 : 5:7
kd0 L L0 ; at L > L0 1
1-Year Companies Let us start from 1-year companies. For them, we get the
following results (Table 5.4 and Figs. 5.14 and 5.15).
Table 5.4 kd and WACC for 1-year companies

L 0 0.2 0.4 0.6 0.8 1 2 3 4
wd 0.000 0.167 0.286 0.375 0.444 0.500 0.667 0.750 0.800
we 1.000 0.833 0.714 0.625 0.556 0.500 0.333 0.250 0.200
0.01 kd 0.12 0.12 0.12 0.12 0.12 0.12 0.11 0.08 0.03
0.1 kd 0.12 0.12 0.12 0.12 0.12 0.12 0.02
0.01 WACC 0.220 0.213 0.208 0.204 0.201 0.199 0.193 0.195 0.207
0.1 WACC 0.220 0.213 0.208 0.204 0.201 0.199 0.213
0.01 ke 0.22 0.24 0.25 0.27 0.29 0.3 0.4 0.59 0.94
0.1 ke 0.22 0.24 0.25 0.27 0.29 0.3 0.61

WACC(L), Ke(L), Kd(L) at =0.01
100%
of capital, WACC, on 90%
leverage level L in case of 80%
quadratic decrease of debt
cost kd, at 0:01 for 70%
1-year company 60%
50%
40%
30%
20%
10%
0%
0 1 2 3 4 5
L
Fig. 5.15 Dependence of WACC(L), Ke(L), Kd(L) at =0.1

debt cost kd, equity cost ke, 70%
cost, kd, at 0:1 for 50%
1-year company
40%
30%
20%
10%
0%
0 1 2 3 4 5
L
3-Year Companies For 3-year companies, we get the following results (Table 5.5
and Figs. 5.16 and 5.17).

L 0 0.2 0.4 0.6 0.8 1 2 3 4
wd 0.000 0.167 0.286 0.375 0.444 0.500 0.667 0.750 0.800
we 1.000 0.833 0.714 0.625 0.556 0.500 0.333 0.250 0.200
0.01 kd 0.12 0.12 0.12 0.12 0.12 0.12 0.11 0.08 0.03
0.1 kd 0.12 0.12 0.12 0.12 0.12 0.12 0.02
0.01 WACC 0.220 0.214 0.210 0.207 0.205 0.203 0.199 0.202 0.212
0.1 WACC 0.220 0.214 0.210 0.207 0.205 0.203 0.215
0.01 ke 0.22 0.24 0.26 0.27 0.29 0.31 0.42 0.62 0.97
0.1 ke 0.22 0.24 0.26 0.27 0.29 0.31 0.61
Fig. 5.16 Dependence of 120%

debt cost kd, equity cost ke, WACC(L), Ke(L), Kd(L) at =0.01
and weighted average cost 100%
80%
cost, kd, at 0:01 for
3-year company 60%
40%
20%
0%
0 1 2 3 4 5
L

70%
50%
3-year company
40%
30%
20%
10%
0%
0 1 2 3 4 5
L
5-Year Companies For 5-year companies, we get the following results (Table 5.6
and Figs. 5.18 and 5.19).

L 0 0.2 0.4 0.6 0.8 1 2 3 4
wd 0.000 0.167 0.286 0.375 0.444 0.500 0.667 0.750 0.800
we 1.000 0.833 0.714 0.625 0.556 0.500 0.333 0.250 0.200
0.01 kd 0.12 0.12 0.12 0.12 0.12 0.12 0.11 0.08 0.03
0.1 kd 0.12 0.12 0.12 0.12 0.12 0.12 0.02
0.01 WACC 0.220 0.213 0.208 0.205 0.202 0.200 0.194 0.197 0.210
0.1 WACC 0.220 0.213 0.208 0.205 0.202 0.200 0.214
0.01 ke 0.22 0.24 0.25 0.27 0.29 0.3 0.41 0.6 0.95
0.1 ke 0.22 0.24 0.25 0.27 0.29 0.3 0.61

90%
70%
5-year company 60%
50%
40%
30%
20%
10%
0%
0 1 2 3 4 5
L

5-year company
40%
30%
20%
10%
0%
0 1 2 3 4 5
L
10-Year Companies For 10-year companies, we get the following results

(Table 5.7 and Figs. 5.20 and 5.21).

L 0 0.2 0.4 0.6 0.8 1 2 3 4
wd 0.000 0.167 0.286 0.375 0.444 0.500 0.667 0.750 0.800
we 1.000 0.833 0.714 0.625 0.556 0.500 0.333 0.250 0.200
0.01 kd 0.12 0.12 0.12 0.12 0.12 0.12 0.11 0.08 0.03
0.1 kd 0.12 0.12 0.12 0.12 0.12 0.12 0.02
0.01 WACC 0.220 0.213 0.208 0.205 0.202 0.200 0.194 0.197 0.210
0.1 WACC 0.220 0.213 0.208 0.205 0.202 0.200 0.214
0.01 ke 0.22 0.24 0.25 0.27 0.29 0.3 0.41 0.6 0.95
0.1 ke 0.22 0.24 0.25 0.27 0.29 0.3 0.61

80%
10-year company
60%
50%
40%
30%
20%
10%
0%
0 1 2 3 4 5
L

10-year company 50%
40%
30%
20%
10%
0%
0 1 2 3 4 5
L
Let us valuate the optimum position L* and its depth WACC, using obtained
results (Table 5.8).
Table 5.8 Optimum position L* and its depth WACC for lifetimes n 1, 3, 5, and 10
Optimum position L* Optimum depth WACC
n 1 3 5 10 1 3 5 10
0:01 2 2 2 2 2.7 % 2.1 % 2.6 % 2.6 %
0:1 11.1 1 11.1 11.1 2.1 % 1.7 % 2.2 % 2.2 %
Discussion of Results Thus, we have considered the impact of reducing the cost of
debt kd with increases of debt volume. We deal with two cases: quadratic and an
exponential dependence of cost of debt kd on leverage. We have considered as well
other dependences, giving similar results.
It is shown that in considered cases, the equity capital cost of firm correlates with
the debt cost, which leads to the emergence of an optimal capital structure of
companies. Cause of the emergence of an optimal structure is that the speed of
increase of equity cost ke of the firm begins to grow, starting from some leverage
level L *, which not only compensates the fall in cost of debt kd with leverage, but it
has also led to an increase in weighted average cost of capital WACC with leverage,
starting from some leverage level. This leverage level determines the optimal
capital structure of company.
It was found that in all examined cases (quadratic as well as exponential one fall
of debt cost), in case of weak drops in debt cost with leverage ( 0:01 ), the
optimal capital structure of the company is formed at bigger leverage values, than
the beginning of the fall (in our case L* / 2L0), and in the case of a stronger fall of
kd ( 0:1), the optimal capital structure of the company is formed directly above
the start point of the fall of kd (L* L0 ).
It turns out that the depth of optimum (and, accordingly, the achieved in
optimum company capitalization) is bigger at weak drops of debt cost with leverage
( 0:01), that is, due to the more long-term fall of the weighted average cost of
capital WACC with leverage L in this case.
5.3 Simple Model of Proposed Mechanism
The features of the proposed mechanism can be demonstrated at its simplest

example of step-like dependence of debt cost on leverage in the BFO model.
Let us suppose,

kd1 0:12 const; at L L0
kd ; k0 0:18; L0 5: 5:8
kd2 0:06 const; at L > L0
We will find the dependence WACC(L ) for 2-year and 4-year companies at T 0.2.
The calculations will be done in MS Excel using BFO formula
1 1 WACCn 1 1 k0 n
; 5:9
WACC k0 1 wd T 1 1 kd n
where wd 1L
L
:
For 2-year company, one gets the following results (Table 5.9).
Table 5.9 Dependence of WACC(L ) for company with lifetime n 2

L 0 1 2 3 4 5 6 7 8 9 10
WACC, % 18 16.33 15.8 15.52 15.35 15.23 16.45 16.42 16.39 16.37 16.35
and following Fig. 5.22.

5.3 Simple Model of Proposed Mechanism 89

WACC(L); n=2
18.50%
level L in case of step-like 18.00%
decrease of debt cost for
2-year company 17.50%
17.00%
WACC
16.50%
16.00%
15.50%
15.00%
0 2 4 6 8 10
L
Similar calculations for 4-year company are given at Fig. 5.23.
Fig. 5.23 Dependence of WACC(L); n=4

weighted average cost of 18.50%
level L in case of step-like 17.50%
4-year company 16.50%
WACC
15.50%
14.50%
13.50%
0 2 4 6 8 10
L
Let us compose the mutual figure for 2-year company and for 4-year company
(Fig. 5.24).
Fig. 5.24 Dependence of WACC(L); n=2 & n=4

weighted average cost of 18.50%
level L in case of step-like
17.50%
2-year (two upper curves)
and 4-year companies (two 16.50%
WACC
lower curves)
15.50%
14.50%
13.50%
0 2 4 6 8 10
L
It can be easily seen that weighted average cost of capital, WACC, decreasing
with leverage, in descending point of cost of credit, has a gap (jump up) and then
continues to decrease, however, with a slower speed, corresponding to the higher
leverage levels. This means that there is an optimum (minimum) in the dependence
of weighted average cost of capital WACC on leverage. The optimum depth in this
model is equal to the gap value in the descending point of cost of credit.
With increase of the lifetime of companies, the total lower of graph takes place:
weighted average cost of capital WACC decreases. The optimum depth does not
change: for biennial and quadrennial companies, it remains equal to 1.32 % (for this
values set of k0, kd, kd, L0).
It should be noted that this model with step-like decrease of debt cost, in spite of
its simplicity, turns out to be a realistic: many credit organizations use this scheme.
For continuous descending of credit cost, weighted average cost of capital, WACC,
is also continuous, and minimum is described by a more familiar bowl, as it was
shown above for exponential and quadratic decrease of credit cost.
Conclusion
1. The ModiglianiMiller theory in its classical version does not consider risky
debt funds in principle; therefore, within this theory, it is not possible to
investigate the current problem.
2. In the modified (by us) theory of ModiglianiMiller, with the modeling of
riskiness of debt funds by dependence of their cost on leverage level, as shown
in this chapter, at arbitrary change of debt cost with leverage (the growing as
well as the falling), the weighted average cost of capital WACC always
decreases with leverage, that demonstrates the absence of the optimal capital
structure and proves insolvency of well-known classical trade-off theory in its
original formulation as well as the inability to implement the mechanism of
formation of an optimal capital structure proposed in this chapter.
3. Within modern theory of capital cost and capital structure by BrusovFilatova
Orekhova (BFO theory), it is shown that decrease of debt cost with leverage
leads to the formation of minimum in dependence of the weighted average cost
of capital WACC on leverage at moderate leverage levels (far from critical ones,
at which financial distressed appear and the bankruptcy risk increases). Exis-
tence of minimum in dependence of the weighted average cost of capital WACC
on leverage leads to maximum in company capitalization (Fig. 5.25).
Thus, a new mechanism of formation of optimal capital structure of the
company, different from the one suggested by trade-off theory (now insolvent)
and which is based on the decrease of debt cost with leverage, has developed by us
and is described in this Chapter.
The cause of optimum formation is as follows: decrease of debt cost with
leverage leads to more significant growth of equity cost, which is not compensated
by the fall of the debt cost, and WACC starts to increase with leverage at some
(moderate) leverage level. From the other side, the increase of debt cost with
leverage at higher leverage level, as we have shown before (Brusov et al. 2013a),
References 91
Fig. 5.25 Mechanism of

formation of optimal capital
structure of the company,
different from one
suggested by trade-off
theory. Decrease of debt
cost with increase of credit
volume in leverage range
from L0 up to L1 leads to the
formation of optimum in
dependence of WACC(L) at
L Lopt
leads to the fall of WACC with leverage. Thus, within BFO theory, under sugges-
tion of decrease of debt cost at moderate leverage levels and of its increase at high
leverage levels, WACC first decreases with leverage, then, going through mini-
mum, starts to grow and finally fall again already continuously (under growing or
constant debt cost). Note, that continuous fall of WACC with leverage at high
leverage levels has been proved by us in previous chapter [see also Brusov
et al. 2013a], where the insolvency of well-known classical trade-off theory has
been demonstrated.
Obtained conclusions do not depend qualitatively on velocity of debt cost fall.
Only optimum depth and its position (but not its existence) depend on the particular
form of dependence of debt cost on leverage [mainly on velocity of debt cost fall
and significantly less on the particular form of function f(L)].
References
Brennan M, Schwartz E (1978) Corporate income taxes, valuation, and the problem of optimal
capital structure. J Bus 51:103114
Brennan M, Schwartz E (1984) Optimal financial policy and firm valuation. J Financ 39:593607
(11):815824
http://dx.doi.org/10.1080/23322039.2014.946150

2:1621
Leland H (1994) Corporate debt value, bond covenants, and optimal capital structure. J Financ 49
(4):12131252
Econ Rev 53:147175
19541957. Am Econ Rev 56:333391
Myers S (2001) Capital structure. J Econ Perspect 15:81102
Chapter 6
The Global Causes of the Global Financial
Crisis
Whether it is possible to manage the finance, being unable to properly assess them
Hopes of ending the financial crisis did not materialize. Recent events (the
problems of the euro zone, the threat of default in the USA, the collapse of the
financial market after a reduction of the credit rating of the USA, debt problems in
the world (Europe, USA), etc.) show that the crisis deepened, affecting new areas
and taking on a systemic character.
It becomes clear that we need in-depth analysis of its general, systemic causes. In
this chapter, we describe recent results in this field, obtained by the authors.
Analysts have called for a lot of particular specific reasons that have led to the
global financial crisis in 2008: the crisis in mortgage lending in the USA, unscru-
pulous financial statements of a number of leading investment funds, problems in
the booming derivatives market in recent years, and others.
But, as our recent researches show, there are also global, fundamental causes of
the current and future financial crises. And one important cause of this is the wrong
long-term systematic assessment of key financial parameters of companies: their
capitalization, the value of attracting funds, including the cost of equity and
weighted average cost of capital. To illustrate the importance of a correct evalua-
tion of financial parameters, we give only one example, associated with a reduction
of the credit rating of the USA.
When the rating agency Standard and Poors informed the Obama administration
about the decision to lower credit ratings, the White House has pointed out to
representatives of S&P an error in its calculations in the trillions of dollars. After
the official downgrade of the U.S. credit rating, government has publicly stated
about these errors. The representative of the U.S. Treasury Department stated:
Built on an error in the $2 trillion in the analysis of S&P, which led to a decrease
in the rating speaks for itself. Last month, S&P warned that only spending budget
cuts by $4 trillion will be able to prevent a fall. However, Congress approved the
plan, which included a reduction by only $2.4 trillion over 10 years. According to
the estimates of S&P, this means that the U.S. foreign debt could reach 74 % of
GDP by the end of 2011, 79 % by 2015, and 85 % by 2021. Moodys and Fitch

DOI 10.1007/978-3-319-14732-1_6
94 6 The Global Causes of the Global Financial Crisis
Ratings, in turn, affirmed the top rating of the USA after Barack Obama signed the
bill, preventing default on August 2.
Thus, we have, on the one hand, the White House, President Obama (stated that
America always will be the country with the AAA rating), and agencies Moodys
and Fitch and, on the other hand, agency Standard & Poors, whose decision
brought down the markets on August 8, 2011, and the difference in the assessment
of about $2 trillion.
Leaving aside the question of a possible trade of insider information, we note
that this is a striking example which demonstrates the great importance of quanti-
tative assessments in the finance areas and the utmost responsibility in financial
calculations.
As it has been shown by us (Brusov et al. 2012b), a primary cause of the crisis of
2008 was a mortgage crisis in the USA, which is associated with overvalued
capitalization of mortgage companies by rating agencies, using incorrect Modi-
gliani and Miller (MM) theory. This reason is now (in 2015) understood by the US
Government, which requires $1 billion from rating agency Standard & Poors for
overvalued capitalization of mortgage companies.
And let us cite the last news on this topic from The New York Times(2015/
01/21): The international rating agency Standard & Poors has agreed to pay
nearly $80 million fine to the US authorities. The relevant agreements S&P has
reached with the Securities and Exchange Commission. The Agency also agreed
to take the annual timeout and to refrain from assign a rating of a number of
investments in commercial mortgage. For the purposes of this agreement the fine
in the $1.37 billion threatens to the agency on the case of inflated ratings.
Let us pose the rhetorical question: whether it is possible to manage by the
finance, being unable to properly consider them.
The current system of assessment of key financial parameters of the companies
goes back to Nobel Prize winners Modigliani and Miller (odigliani and iller
1958, 1963, 1966), who half a century ago replaced existing at that time empirical
intuitive approach (lets call it traditional). The theory of ModiglianiMiller has
been established under a number of limitations, which obviously had a rough model
character and had a very weak relationship to the real economy. Among the
limitations, it is sufficient to mention the lack of corporate and individual income
taxes, perpetuity (infinite lifetime) of the companies, the existence of perfect
markets, etc. Some restrictions (such as a lack of corporate and individual income
taxes, etc.) were removed later by the authors themselves and their followers, while
others (such as perpetuity of companies) remained in the approach of Modigliani
Miller, until recently. However, since the theory of ModiglianiMiller (odigliani
and iller 1958, 1963, 1966) was the first quantitative theory, and since finance is
essentially a quantitative science, the theory has become widely used in practice,
since it gave even inaccurate, even rude, but at least some quantitative estimates of
key financial parameters of companies; thus, it was necessary as an air for fore-
casting activities of the companies and to make informed management decisions.
Widespread use of the ModiglianiMiller theory, as usual, led to the neglect of
restrictions on which it was based and to the absolutization of the theory.
6 The Global Causes of the Global Financial Crisis 95
As it has been shown by BrusovFilatovaOrekhova (Brusov and Filatova 2011;

Brusov et al. 2011a, b, c, 2012a, b, 2013a, b, 2014a, b; Filatova et al. 2008), the
theory of ModiglianiMiller (odigliani and iller 1958, 1963, 1966), to put it
mildly, does not adequately evaluate the most important financial indicators of the
company. It yields significantly lower estimates of weighted average cost of capital
and of the value of its equity, compared with the actual estimates. This underesti-
mation leads to overestimated values of capitalization of the company.
The first researcher, who drew attention to the fact that the calculations of
weighted average cost of capital in the theory of ModiglianiMiller are inaccurate,
was Myers (2001), who derived a formula for the weighted average cost of capital,
WACC, for one-year project. He suggested that the estimate given by the theory of
ModiglianiMiller is the lowest bound estimate of weighted average cost of capital
[our recent discovery. Brusov et al. (2015) show that,, however, this statement by
Myers turns out to be wrong (see Chap. 18 for details)].
The general solution of the problem of weighted average cost of capital for
companies with an arbitrary finite lifetime (arbitrary age) was first obtained by
BrusovFilatovaOrekhova (Brusov and Filatova 2011; Brusov et al. 2011a, b, c,
2012a, b, 2013a, b, 2014a, b; Filatova et al. 2008).
Note that the results of their theory are applicable not only to companies with a
finite lifetime, which had completed its work, but also to existing companies which
give the opportunity to assess the real value of equity cost and its weighted average
capital cost, supposing that the company existed to date n years (is an n years old).
Let us give a couple of graphic illustrations of their results, for equity cost and
for weighted average capital cost (Figs. 6.1 and 6.2).
Results obtained by BrusovFilatovaOrekhova (Brusov and Filatova 2011;
Brusov et al. 2011a, b, c, 2012a, b, 2013a, b, 2014a, b; Filatova et al. 2008) show
that the theory of ModiglianiMiller (odigliani and iller 1958, 1963, 1966), due
to its perpetuity, underestimates (and often significantly) an assessment of weighted
average cost of capital, cost of equity of the company, and inflating (also often
significant) estimate of the capitalization of leverage companies as well as of
financially independent companies.
Such incorrect estimations of the basic financial parameters of companies lead
to an underestimation of the financial risks, the impossibility, or severe difficul-
ties in making appropriate management decisions, which is one of the implicit
reasons for the financial crisis.
Brusova (2011) has made a comparative analysis of the calculation of the cost of
equity and weighted average cost of capital of one of the leading telecommunica-
tion companies in Russia by three methods: traditional, ModiglianiMiller method,
and BrusovFilatovaOrekhova. She has shown that the least accurate is the
traditional approach. Better results are obtained by the method of Modigliani
Miller (and this was the reason that it is used more than half-century). And the

equity cost, ke, on leverage
L in the absence of
corporate taxes [the upper
line (t 0)], as well as in the
presence of corporate taxes
[for one-year (n 1) and
perpetuity companies
(n 1)]. Dependences of
the cost of equity capital of
companies, ke, with an
intermediate lifetime (1 < n
< 1) lie within the shaded
region
most relevant results are provided by the BrusovFilatovaOrekhova method

(Fig. 6.3). See Chap. 17 for more details.
Note that the present methods of estimation of the main financial parameters of
companies are a blend of the traditional approach and the method of Modigliani
Miller. If we will continue the use of the existing system of evaluation of financial
indicators, it will inevitably be the hidden global cause of new financial crises
because it does not allow us to make informed management decisions. The danger
of the situation found by us is that the causes for the crisis do not lie on the surface,
they are implicit and hidden, though no less important and significant. Therefore,
the problem of their identification and disclosure is extremely important and
relevant. Informedso protected.
Authors are working now on the development of methodology for assessing the
key financial parameters of the companies on the basis of the BrusovFilatova
Orekhova theory.
The conclusion is that we must globally transform the system of assessment of
key financial parameters of companies: their capitalization, the cost of equity, and
weighted average cost of capital, in order to lower the financial risks. This will
lower the danger of global financial crisis.
The authors are aware of the complexity of the taskto transform the worlds
system of evaluation of the basic financial parameters of the companies to a new,
more realistic basis, it will take years and years, but there is no other way for the
world economic community.
6 The Global Causes of the Global Financial Crisis 97
25.00
24.00
23.00
22.00
21.00
20.00
19.00
18.00
17.00
16.00
WACC
15.00
14.00
13.00
12.00
11.00
10.00
9.00
8.00
7.00
6.00
5.00
0 10 20 30 40 50 60
Wd
Fig. 6.2 The dependence of the WACC on debt share wd for companies with different lifetimes
for different cost of equity, k0 (in each triplet, upper curve corresponds to n 1, middle oneto
n 2, and bottom oneto n 1)
Fig. 6.3 Dependence of the weighted average cost of capital of the company, WACC, and equity
cost, ke, on leverage by traditional method (lines 3, 6), by ModiglianiMiller method (lines 2, 5),
and by BrusovFilatovaOrekhova method (lines 1, 4)
References
(11):815824
2:1621
http://dx.doi.org/10.1080/23322039.2014.946150
Brusov P, Filatova T, Orehova N, Kulik V (2015) The golden age of the company. J Rev Global
Econ 4:2142
capital and equity cost of company. Financ Anal Probl Sol 34(76):3642
Econ Rev 53:147175
19541957. Am Econ Rev 56:333391
Chapter 7
The Role of Taxing and Leverage
in Evaluation of Capital Cost
and Capitalization of the Company
In this chapter, the role of tax shield, taxes, and leverage in the modern theory of
corporative finance is investigated. ModiglianiMiller theory and modern theory of
capital cost and capital structure by BrusovFilatovaOrekhova are considered. It is
shown that the equity cost, as well as the weighted average cost of capital, decreases
with the tax on profit rate, while the capitalization increases. The detailed investiga-
tion of the dependence of the weighted average cost of capital WACC and the equity
cost ke on the tax on profit rate at fixed leverage (debt capital fraction wd) and on the
leverage level at fixed tax on profit rate, as well as the dependence of WACC and ke
on company lifetime (age), is made. We have introduced the concept of tax operation
leverage. For companies with finite lifetime (finite age), a number of important
qualitative effects, which have no analogies for perpetuity companies, are found.
In Chap. 2, it has been noted that Modigliani and Miller in their paper in 1958
(odigliani and iller 1958) have come to conclusions, which are fundamentally
different from the conclusions of traditional approach. They have shown that, in the
framework of assumptions made by them, the ratio between equity and debt capital
in the company neither affects the cost of capital nor the company value.
In the context of the study of the impact of tax on profit rate on the cost of capital
and on the company capitalization, we raised among the numerous assumptions of
Modigliani and Miller two of the most important:
1. Corporate taxes and taxes on personal income of investors are absent.
2. All financial flows are perpetuity ones.
From the first of these assumptions, Modigliani and Miller subsequently refused
themselves and have modified their theory to the case of presence of corporate taxes
and taxes on personal income of investors that have significantly altered the
conclusions of their theory (odigliani and iller 1963, 1966).
The failure of the second assumption has led to the creation of modern theory of
capital cost and capital structure by BrusovFilatovaOrekhova (BFO theory)
(Brusov and Filatova 2011; Brusov et al. 2011a, b, c, 2012a, b, 2013a, b, 2014a,
b; Filatova et al. 2008; Brusova 2011).

DOI 10.1007/978-3-319-14732-1_7
100 7 The Role of Taxing and Leverage in Evaluation of Capital Cost and. . .
7.1 The Role of Taxes in ModiglianiMiller Theory
We analyze now the role of taxes in the ModiglianiMiller theory, studying the
dependence of weighted average cost of capital WACC and the equity cost ke of tax
on profit rate T.
With this purpose, we analyze the following formulas:
1. for weighted average cost of capital WACC, one has
WACC k0 1 wd T ; 7:1
WACC k0 1 LT=1 L;
2. for the equity cost ke, one has

ke k0 L1 T k0 kd : 7:2
Both dependences are linear: both costs of capital decrease linearly with the
increase of tax on profit rate T.
For dependence of weighted average cost of capital WACC on tax on profit rate
T, negative tangent of tilt angle in tg k0 L=1 L is growing in the module
with the increase of the leverage level, L, achieving maximum, equal to k0 at an
infinite leverage level L 1 (share of equity capital is insignificantly small
compared with the fraction of debt funds) (Fig. 7.1).
Let us give a few examples:
1. In accordance with expression tg k0 L=1 L, one gets that at k0 10 %
and L 1, i.e., D S, increase of tax on profit rate T on 10 % leads to decrease
of weighted average cost of capital WACC on 0.5 %.

of weighted average cost of
capital WACC on tax on
profit rate T at different
fixed leverage level L
7.1 The Role of Taxes in ModiglianiMiller Theory 101
2. This dependence of weighted average cost of capital WACC on tax on profit rate
T will be even more significant at a higher leverage level L and higher value k0.
For example, at k0 20 % and L 2, the increase in T on 10 % leads to a
decrease in WACC on 1.33 %.
For dependence of the equity cost ke on tax on profit rate T (from the analysis
of formula ke k0 L1 T k0 kd ) it is seen that negative tangent of tilt
angle tg Lk0 kd also increases in the module with the increase of the
leverage level, in this connection all dependences at the different leverage levels
Li, based on the different points ke k0 Li k0 kd when T 0, at T 1
converge at the point k0.
3. In accordance with the formula tg Lk0 kd , we get that when k0 kd 6 %
andL 1, i..,D S, the increase of tax on profit rate T on 10 % leads to a reduction
in the equity capital cost ke on 0.6 %.
4. This dependence of the equity cost ke on tax on profit rate T will be even more
significant at a higher leverage level L and higher value k0 kd . For example, at
k0 kd 10 % and L 2, the increase in T on 10 % leads to a decrease in ke on
2 %.
It should be noted that with the rising of tax on profit rate T, the difference in the
equity cost ke at various levels of leverage decreases, disappearing at T 1.
This procedure recalls operational analysis, which examined dependence of
financial results of the activities of the company on the costs and volumes of
production and the implementation of the products, goods, and services. The key
elements of operational analysis of any enterprise are operating lever, the threshold
of cost-effectiveness, and stock financial strength of enterprise. The operational arm
is reflected in the fact that any change proceeding from the disposal always gives
rise to a more severe change in earnings.
In the present case, as the effects of tax operational lever can be taken as the
ratio of change of weighted average cost of capital WACC to the change of tax on
profit rate T, and the ratio of change of equity capital cost ke to the change of tax on
profit rate T, i.., we can introduce for the first time two tax operating levers:
for weighted average cost of capital WACC:
LWACC WACC=T;
for equity capital cost ke:
Lke ke =T:
For the earlier examples, the power of the lever is:

1. LWACC 0:05;
2. LWACC 0:133;
3. Lke 0:06;
4. Lke 0:2.

equity capital cost ke on tax
on profit rate T at different
leverage level L
The higher value of the tax operational lever causes the greater change in capital
cost of the company at fixed change of tax on profit rate T (Fig. 7.2).
7.2 The Role of Taxes in BrusovFilatovaOrekhova

Theory
The solution of the problem of evaluation of the weighted average cost of capital
WACC for companies with arbitrary lifetime (arbitrary age), as it was noted in
Chap. 3, has been done for the first time by Brusov and Filatova (2011), Brusov
et al. (2011a, b, c, 2012a, b, 2013a, b, 2014a, b), and Filatova et al. (2008).
Following them, consider the situation for the finite lifetime (finite age) of the
company. In this case, the ModiglianiMiller theorem
V L V 0 DT
is changed by
V V 0 PVTS V 0 DT 1 1 kd n ; 7:3
where
7.2 The Role of Taxes in BrusovFilatovaOrekhova Theory 103
X
n t
PVTS kd DT 1kd DT 1 1 kd n ; 7:4
t1
represents a tax shield for n years.

It is seen that the capitalization of financially dependent (leverage) company
linearly increases with the growth of the tax on profit rate (as well as in the limited
case of ModiglianiMiller); however, the tilt angle of the linear function VL(T ) is
less than in the perpetuity case:
tg T 1 1 kd n T: 7:5
We will carry out the study of the dependence of weighted average cost of
capital of the company WACC and its equity cost ke on tax on profit rate in two
ways:
1. We will study the dependence of weighted average cost of capital of the
company WACC and its equity cost ke on tax on profit rate at fixed leverage
level and at different lifetimes (different ages) of the company.
2. We will study the dependence of weighted average cost of capital of the
company WACC and its equity cost ke on leverage level at fixed tax on profit
rate and at different lifetime (different age) of the company.
In both cases, we will use BrusovFilatovaOrekhova formula for weighted
average cost of capital of the company WACC (Brusov and Filatova 2011; Brusov
et al. 2011a, b, c, 2012a, b, 2013a, b, 2014a, b; Filatova et al. 2008):
1 1 WACCn 1 1 k0 n
: 7:6
7.2.1 Weighted Average Cost of Capital

of the Company WACC
Dependence of Weighted Average Cost of Capital of the Company WACC

on Tax on Profit Rate at Fixed Leverage Level L
For n 2, k0 18 %, kd 10 %, the dependences of weighted average cost of
capital of the company WACC on tax on profit rate at fixed leverage level
L (fraction of debt capital wd) are shown at Fig. 7.3.
It is quite obvious that dependences are very similar to that in Fig. 7.1, differing
by the tilt angle and the distance between curves (in fact, the dependences are
very close to the linear ones). With the increase of debt capital fraction wd
(or leverage level L ), the curves become more steep and the relevant tax operating
lever decreases, which means the rise of the impact of the change of the tax on profit
rate on the weighted average cost of capital.
Fig. 7.3 Dependence of WACC

weighted average cost of 0.2000
capital of the company 1
WACC on tax on profit rate
0.1500
at fixed leverage level 2
L (fraction of debt capital
wd): (1) wd 0; (2) wd 0.1000 3
0:2; (3) wd 0:4; (4) wd
4
0:6; (5) wd 0:8; (6) wd 1 0.0500
5
0.0000
0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1 6 1.1
-0.0500
T

capital of the company
0.2500
WACC on debt capital 1
fraction wd at different tax 0.2000
on profit rates : (1) 0; 2
0.1500
(2) 0.2; (3) 0.4;
3
(4) 0.6; (5) 0.8; 0.1000
(6) and 1 4
0.0500
0.0000 5
0 0.2 0.4 0.6 0.8 1 1.2
-0.0500
6
-0.1000
Wd

on Debt Capital Fraction wd at Fixed Tax on Profit Rate
Dependences of weighted average cost of capital of the company WACC on debt
capital fraction wd at fixed tax on profit rate turn out to be linear ones as well. For
example, for n 3, k0 24 %, kd 20 %, we got the dependences, represented at
Fig. 7.4.
The dependences shown at Fig. 7.4 are not surprising because the fraction of
debt capital and tax on profit rate are included in the BrusovFilatovaOrekhova
formula (Eq. 7.5) in a symmetrical manner. With the increase of the tax on profit
rate , the curves become more steep, which means the rise of the impact of the
change of the debt capital fraction wd on the weighted average cost of
capital WACC.
on Leverage Level L at Fixed Tax on Profit Rate
Dependence of weighted average cost of capital of the company WACC on
leverage level L at fixed tax on profit rate becomes an essentially nonlinear.

capital of the company 0.1800 1
WACC on leverage level 0.1600
L at different fixed tax on 0.1400 2
profit rates : (1) 0; 0.1200
(2) 0.2; (3) 0.4; 0.1000
3
(4) 0.6; (5) 0.8; and
0.0800 4
(6) 1
0.0600
0.0400 5
0.0200
0.0000 6
0 1 2 3 4 5 6 7 8 9 10
L
For example, for n 3; k0 18 %, kd 12 %, we got the dependences,

represented at Fig. 7.5.
With the increase of the tax on profit rate , the curve of the dependence of
weighted average cost of capital of the company WACC on leverage level
L becomes more steep, i.e., at the same leverage level L; its change leads to bigger
change of WACC at higher tax on profit rate .
At tax on profit rate T 40 %, weighted average cost of capital of the company
WACC locates within kd WACC k0 .
At tax on profit rate T 40 %, weighted average cost of capital of the company
WACC falls below kd at certain leverage level L*, which decreases with increase
of T.
7.2.2 Equity Cost ke of the Company
Dependence of Equity Cost ke of the Company on Tax on Profit Rate at Fixed

Leverage Level L
Here are three figures, showing the dependence of equity cost ke on tax on profit rate
at different (fixed) leverage levels (debt capital fraction wd) for different parameter
sets n, k0, kd (Figs. 7.6, 7.7, and 7.8).
It should be noted that:
1. All dependencies are linear, and ke decreases with increasing tax on profit rate
.
2. With the increase of the debt capital fraction wd, initial values ke significantly
grow and exceed k0.
3. Lines, corresponding to the different values of the debt capital fraction wd,
intersect at the same point (at a certain value of tax on profit rate T*),
dependent on parameters n, k0, kd (Figs. 7.6 and 7.7).
Fig. 7.6 Dependence of Ke

equity cost ke of the 0.2700
company on tax on profit
0.2500
rate at fixed debt capital
fraction wd (n 5, k0 10 0.2300
%, kd 6 %): (1) wd 0; 0.2100
(2) wd 0:2; (3) wd 0:4;
(4) wd 0:6; and (5) 0.1900
wd 0:8 0.1700
5
0.1500
4
0.1300 3
0.1100 2
0.0900 1
0.0700 T
0 0.2 0.4 0.6 0.8 1 1.2

fraction wd (n 10, k0 10 0.1500
%, kd 8 %): (1) wd 0;
(2) wd 0:2; (3) wd 0:4; 0.1000 1
(4) wd 0:6; and (5) 2
3
wd 0:8
0.0500
4
0.0000
0 0.2 0.4 0.6 0.8 1 1.2
-0.0500
5
-0.1000
T
4. At some values of parameters n, k0, kd, the crossing of all lines at a single
point cannot take a place at any tax on profit rate 0 < T 100 %. With a large
gap between k0 and kd, a point of crossing of all the lines lies in the
nonexistent (the nonfinancial) region T* > 100 % (Fig. 7.8). For data of
Fig. 7.8, T* 162 %.
Dependence of Equity Cost ke of the Company on Leverage Level L on Fixed
Tax on Profit Rate
The results of the calculations of dependence of equity cost ke of the company on
the leverage level L in Excel for the case, n 7, k0 20 %, kd 10 % (at a fixed tax
on profit rate ), are presented in the Table 7.1 and in the Fig. 7.9.

0.6000
fraction wd (n 3, k0 20 0.5500
%, kd 10 %): (1) wd 0;
0.5000
(2) wd 0:2; (3) wd 0:4;
(4) wd 0:6;and (5) 0.4500
wd 0:8
0.4000
0.3500
5
0.3000
0.2500 4
3
0.2000 2
1
0.1500 T
0 0.2 0.4 0.6 0.8 1 1.2
Dependence of equity cost ke of the company on leverage level L on fixed tax on

profit rate with a good accuracy is linear. When the tilt angle decreases with
increasing tax on profit rate , as in the perpetuity case (Fig. 7.9).
However, for companies with finite lifetime (finite age), along with the behavior
ke(L), similar to behavior in case of ModiglianiMiller perpetuity companies
(Fig. 7.9), for some sets of parameters n, k0, kd, there is a different dependence ke(L).
For example, starting with some of the values of tax on profit rate T* (in this
case, T* 40 %, although for the other parameter sets n, k0, kd, a critical tax on
profit rate T* could be even less), one has not the growth of the equity capital cost of
the company with leverage level but it is descending (Fig. 7.10). Let us repeat once
more that existence or absence of this effect depends on a set of parameters k0, kd, n.
Note that this is a principally new effect, which may take place only for the
company with the finite lifetime (finite age) and which is not observed in perpetuity
limit. For example, from the formula
ke k0 L1 T k0 kd ; 7:7
it follows that at T 1100 %, equity cost ke does not change with leverage:
ke k0 , i.e., descending of equity cost ke with leverage, does not occur at any tax on
profit rate T. Thus, discovered effect does NOT take place in perpetuity
ModiglianiMiller limit.
7.2.3 Dependence of WACC and ke on Lifetime (Age)

of Company
The issue of dependency of WACC and ke on the length of life of the company
within the theory of ModiglianiMiller even though it is not possible to place: in
108
Table 7.1 Dependence of equity cost ke of the company on leverage level L on fixed tax on profit rate for the case n 7, k0 20 %, kd 10 %
L
T 0.0 1.0 2.0 3.0 4.0 5.0 6.0 7.0 8.0 9.0 10
0.0 0.2000 0.3000 0.4000 0.5000 0.6000 0.7000 0.8000 0.9000 1.0000 1.1000 1.2000
0.2 0.2000 0.2842 0.3682 0.4522 0.5362 0.6202 0.7042 0.7874 0.8713 0.9551 1.0389
0.4 0.2000 0.2677 0.3344 0.4008 0.4672 0.5335 0.5998 0.6661 0.7323 0.7986 0.8649
0.6 0.2000 0.2504 0.2984 0.3457 0.3928 0.4397 0.4865 0.5334 0.5802 0.6265 0.6731
0.8 0.2000 0.2323 0.2601 0.2861 0.3117 0.3369 0.3619 0.3867 0.4116 0.4364 0.4612
1.0 0.2000 0.2132 0.2185 0.2210 0.2223 0.2229 0.2231 0.2233 0.2231 0.2228 0.2224
7 The Role of Taxing and Leverage in Evaluation of Capital Cost and. . .

equity cost ke of the
1.4000
company on leverage level
L on fixed tax on profit rate 1.2000 1
for the case n 7, k0
2
20 %, kd 10 %: (1) T 0; 1.0000
(2) T 0:2; (3) T 0:4; (4) 3
T 0:6; (5) T 0:8; and 0.8000
(6) T 1 0.6000
4
0.4000 5
0.2000 6
0.0000
0 1 2 3 4 5 6 7 8 9 10 11
L

company on leverage level
L on fixed tax on profit rate
for the case: n 5, k0 0.3000 1
10 %, kd 8 %: (1) T 0;
(2) T 0:2; (3) T 0:4; (4) 0.2000 2
T 0:6; (5) T 0:8; and
(6) T 1
0.1000 3
4
0.0000
0 0.5 1 1.5 2 2.5 3 3.5 4 4.5 5 5.5 6 6.5 7 7.5 8 8.5 9 9.5 1010.5
-0.1000
5
-0.2000
6
-0.3000
L
their theory, the parameter time is absent, since all the companies are
perpetuity ones.
Within the modern BrusovFilatovaOrekhova theory, it becomes possible to
study the dependence of WACC and ke on the companys lifetime (age). Below, we
will undertake a detailed study of this problem: the dependences WACC(n) and
ke(n) will be examined at different tax on profit rate T and leverage level L for
different sets of parameters k0, kd, T, wd.
on Lifetime (Age) of Company at Different Fixed Tax on Profit Rate T
Considering dependence is shown at Fig. 7.11.

0.1200
WACC on lifetime (age) of
0.0800 2
company at different fixed tax
on profit rate T (wd 0:7, 3
0.0600
k0 10 %, kd 8 %): 4
(1) T 0; (2) T 0:2; 0.0400
(3) T 0:4; (4) T 0:6; (5) 5
T 0:8; (6) T 1 0.0200
6
0.0000
0 5 10 15 20 25 30
n

WACC on lifetime (age) of 2
company at different 0.0800 3
fixed fraction of debt capital 4
0.0600 5
wd (T 40 %, k0 10 %, kd 6
8 %): (1) wd 0; (2) wd 0.0400
0:2; (3) wd 0:4; (4) wd
0.0200
0:6; (5) wd 0:8
0.0000
0 5 10 15 20 25 30
n
Weighted average cost of capital of the company WACC decreases with increas-
ing lifetime, n, of the company in an effort to its perpetuity limit. The initial values
WACC (at n 1) will decrease with increasing of tax on profit rate T (in accordance
with the previously received dependences WACC(T )) and a range of WACC
changes is growing with increasing T.
on Lifetime (Age) of Company at Different Fixed Fraction of Debt Capital wd
Considering dependence is shown at Fig. 7.12.
The weighted average cost of capital of the company WACC decreases with the
lifetime of company n, tending to its perpetuity limit. The initial values WACC
(at n 1) decrease with the increase of fraction of debt capital [in accordance with
the previously received dependences WACC(wd)], and a range of WACC changes
is growing with increasing of wd.
Dependence of Equity Cost of the Company ke on Lifetime (Age) of Company
n at Different Fixed Fraction of Debt Capital wd
Considering dependence is represented at Fig. 7.13.
The equity cost of the company ke decreases with the lifetime (age) of company
n, tending to its perpetuity limit. The initial values ke (at n 1) decrease

equity cost of the company ke 0.2000
on lifetime (age) of company
0.1800
n at different fixed fraction of
debt capital wd (T 20 %, 0.1600
5
k0 10 %, kd 8 %): 0.1400
(1) wd 0; (2) wd 0:2; (3) 0.1200 4
wd 0:4; (4) wd 0:6; and 32
0.1000
(5) wd 0:8 1
0.0800
0.0600
0.0400
0.0200
0.0000
0 5 10 15 20 25 30
n

equity cost of the company ke
on lifetime (age) of company 0.1900
n at different fixed fraction of
debt capital wd (T 40 %, k0 0.1700
10 %, kd 8 %): (1) wd
0; (2)wd 0:2; (3)wd 0:4; 0.1500
(4) wd 0:6; and (5)
wd 0:8 0.1300
5
0.1100 4
3
2
1
0.0900
0 5 10 15 20 25 30
n
significantly with the increase of fraction of debt capital wd. A range of ke changes is
growing with increasing of wd.
It should be noted that the differences in equity cost of the company at a fixed n,
starting from wd 0:5, become and remain significant (and constant for a fixed
change in the fraction of debt capital wd and at n 6).
The situation will change with increase of tax on profit rate T. To demonstrate
this fact we show the similar data, increasing tax on profit rate T twice (from 20 %
up to 40 %) (Fig. 7.14).
It can be observed that with increase in tax on profit rates in two times, the
region, where the differences in equity cost of capital ke of the company are feeling
at various fractions of debt capital wd have narrowed down to 6 years, while at
n 6, equity cost of capital ke remains virtually equal to k0 and only slightly
fluctuates around this value.

equity cost of the company
ke on lifetime (age) of 0.3000
company n at different fixed
tax on profit rates T (wd 0.2500 1
0:7, k0 16 %, kd 12 %): 2
(1) T 0; (2) T 0:2; (3) 0.2000 3
T 0:4; (4) T 0:6; (5) T 4
0:8; and (6) T 1
0.1500
5
0.1000
6
0.0500
0.0000
0 5 10 15 20 25 30
n
Dependence of Equity Cost of the Company ke on Lifetime (Age) of Company

n at Different Fixed Tax on Profit Rate T
Considering dependence is represented at Fig. 7.15.
The equity cost of the company ke decreases with the lifetime (age) of company,
n, tending to its perpetuity limit. Under growing of tax on profit rates T the equity
cost of the company ke decreases (at fixed fraction of debt capital wd, while range of
ke changes increases.
Conclusions In this chapter, the role of tax shields, taxes, and leverage is inves-
tigated within the theory of ModiglianiMiller as well as within the modern theory
of corporate finance by BrusovFilatovaOrekhova (Brusov and Filatova 2011;
Brusov et al. 2011a, b, c, 2012a, b, 2013a, b, 2014a, b; Filatova et al. 2008). It is
shown that equity cost of the company as well as weighted average cost of capital
decreases with the growth of tax on profit rates. A detailed study of the dependence
of weighted average cost of capital WACC and equity cost of the company ke on tax
on profit rates at fixed leverage level (fixed debt capital fraction wd) as well as on
leverage level (debt capital fraction wd) at fixed tax on profit rate has been done.
The dependences of weighted average cost of capital WACC and equity cost of the
company ke on companys lifetime have been investigated as well.
The concept tax operating lever has been introduced. For companies with
finite lifetime, a number of important qualitative effects that do not have analogues
for perpetuity companies have been detected.
One such effectdecreasing of equity cost with leverage level at values of tax
on profit rate T, which exceeds some critical value T*is described in detail in
Chap. 10 (at certain ratios between the debt cost and equity capital cost, discovered
effect takes place at tax on profit rate, existing in the Western countries and in
Russia, that provides practical value of the effect). Taking it into account is
References 113
important in improving tax legislation and may change dividend policy of the
company significantly.
For more detailed investigation of the dependence of attracting capital cost on
the lifetime of company n at various leverage levels and at various values of capital
costs with the aim of defining minimum cost of attracting capital, see Chap. 18,
where new qualitative effects have been discovered.
References
(11):815824
2:1621
http://dx.doi.org/10.1080/23322039.2014.946150
Econ Rev 53:147175
19541957. Am Econ Rev 56:333391
Chapter 8
A Qualitatively New Effect in Corporate
Finance: Abnormal Dependence of Equity
Cost of Company on Leverage
Qualitatively new effect in corporative finance has been discovered by the authors:
decreasing of equity cost ke with leverage L. This effect, which is absent in
perpetuity ModiglianiMiller limit, takes place on account of finite lifetime of the
company at tax on profit rate, which exceeds some value T*.
At some ratios between debt cost and equity cost, the discovered effect takes
place at tax on profit rate existing in Western countries and Russia. This provides
the practical meaning of discussed effect. Taking it into account is important for the
modification of tax law and can change the dividend policy of the company.
In this chapter, the complete and detailed investigation of discussed effect,
discovered within BrusovFilatovaOrekhova theory, has been done. It has been
shown that the absence of the effect at some particular set of parameters is
connected to the fact that in these cases, T* exceeds 100 % (tax on profit rate is
situated in nonfinancial region).
Introduction The structure of this chapter is as follows: first, we consider the
value of the equity cost ke in the theory of Modigliani and Miller, its dependence on
leverage L, and tax on profit rate T to show that in this perpetuity limit, the equity
cost ke is always growing with leverage (for any tax on profit rate T ).
Then, we consider the equity cost ke within the modern BrusvFiltv
Orekhv theory and show that for companies with finite lifetime (finite age), a
qualitatively new effect takes place: decreasing of the equity cost with the leverage.
The effect takes place at tax on profit rate T, exceeding some critical value T*.
Next, we make a complete study of the discovered effect: we investigate the
dependence of T* on companys lifetime (age) n, on equity cost of financially
independent company k0, and on debt cost kd as well as on ratio of these parameters.
We separately consider a 1-year company and analyze its special feature in
connection with the discussed effect. An explanation of the absence of this effect
for such companies will be given. In conclusion, the importance of the discovered
effect in various areas, including improving tax legislation and dividend policies of
companies, as well as the practical value of the effect is discussed.

DOI 10.1007/978-3-319-14732-1_8
116 8 A Qualitatively New Effect in Corporate Finance: Abnormal Dependence of. . .
8.1 Equity Cost in the ModiglianiMiller Theory
For weighted average cost of capital WACC in the ModiglianiMiller theory, the
following expression has been obtained (odigliani and iller 1958, 1963, and
1966):
WACC k0 1 wd T : 8:1
Dependence of WACC on financial leverage L D=S is described by the formula
WACC k0 1 LT=1 L : 8:2
In accordance with definition of the weighted average cost of capital with account-
ing for the tax shield, one has
WACC k0 we kd wd 1 T : 8:3
Equating (Eqs. 8.18.3), we get
k0 1 wd T k0 we kd wd 1 T : 8:4
From where, for equity cost, one has
ke k0 L1 T k0 kd : 8:5
Note that the formula (Eq. 8.5) is different from the corresponding formula without
tax only by multiplier (1 T ) in the term, indicating premium for risk. As the
multiplier is less than unit, the appearance of corporate tax on profit leads to the
fact that equity cost increases with leverage slower than in the case of taxes
absence.
Analysis of formulas (Eqs. 8.1 and 8.5) leads to the following conclusions.
With the increasing of financial leverage:
1. Value of the company is increased.
2. Weighted average cost of capital is decreased from k0 (at L 0) up to k0 1 T
(at L 1, when the company is funded solely by borrowing or its equity capital
is negligible).
3. Equity cost is increased linearly from k0 (at L 0) up to 1 (at L 1).
Let us analyze now the influence of taxes on equity cost in ModiglianiMiller
theory by studying the dependence of equity cost on tax on profit rate.
For this, we will analyze the formula (Fig. 8.1)
ke k0 L1 T k0 kd : 8:6
8.1 Equity Cost in the ModiglianiMiller Theory 117

equity cost, debt cost, and
WACC on leverage without
taxes (t 0) and with taxes
(t 6 0)
It is seen that dependence is linear: equity cost is decreased linearly with tax on
profit rate. The module of negative tilt angle tangent tg Lk0 kd is increased
with leverage, and besides, all dependences at different leverage levels Li, coming
from different points ke k0 Li k0 kd at T 0 and at T 1, are converged at
the point k0 (Fig. 8.2).
This means that the difference in equity cost at different leverage levels Li is
decreased with tax on profit rate T, disappearing at T 1.
Let us illustrate these general considerations by the example
k0 10 %; kd 8 % (Figs. 8.3, 8.4, and 8.5).
From Fig. 8.2, it is seen that dependence is linear: equity cost is decreased
linearly with tax on profit rate. The module of negative tilt angle tangent tg
Lk0 kd is increased with leverage, and besides, all dependences at different
leverage levels Li, coming from different points ke k0 Li k0 kd at T 0 and
at T 1, are converged at the point k0 (Fig. 8.2).
From Fig. 8.4, it is seen that equity cost is increased linearly from k0 (at L 0) up
to 1 (at L 1), and besides, tilt angle tangent is decreased with tax on profit rate T,
becoming zero at T 100 %.
In other words, with increase of tax on profit rate T, dependence of equity cost on
leverage L becomes smaller, disappearing at T 100 %, i.e., within perpetuity
ModiglianiMiller theory, any anomaly effect, announced in the title of this
chapter, is absent.
In conclusion, here is a three-dimensional graph of dependence of equity cost on
leverage L and on tax on profit rate T for the case k0 10 %; kd 8 %.

equity cost on tax on profit
rate T at different leverage
levels Li
Fig. 8.3 Dependence of Ke (T), at fixed L Ke

equity cost on tax on profit 0.3000
rate T ati different leverage
levels L for the case k0 5 0.2500
10 %; kd 8 %: (1) L 0;
(2) L 2; (3) L 4; 4
0.2000
(4) L 6; and (5) L 8
3
0.1500
2
1 0.1000
0.0500
0.0000
0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1 1.1
T
8.2 Equity Cost Capital Within BrusovFilatova

Orekhova Theory
The general solution of the problem of weighted average cost of capital and the
equity cost for the company with finite lifetime (finite age) has been received for the
first time by BrusovFilatovaOrekhova with coauthors (Brusov and Filatova 2011;
2011). They have gotten (now already famous) formula for WACC
8.2 Equity Cost Capital Within BrusovFilatovaOrekhova Theory 119

equity cost on leverage L at Ke (L), at fixed T
0.3000
different tax on profit rates
T for the case k0 10 %;
kd 8 %: (1) T 0; 0.2500 1
(2) T 0:1; (3) T 0:2;
2
3
(4) T 0:3; (5) T 0:4; 0.2000 4
(6) T 0:5; (7) T 0:6; (8) 5
6
T 0:7; (9, 10) T 0:9; 0.1500 7
and (11) T 1 8
9
0.1000 10
11
0.0500
0.0000
0.0 1.0 2.0 3.0 4.0 5.0 6.0 7.0 8.0 9.0
L
Fig. 8.5 Dependence of Ke Ke (L,T)

equity cost on leverage
0.3000
L and on tax on profit rate
T for the case 0.2500
k0 10 %; kd 8 %
0.2000
0.1500
0.1000
0.0500
0.0000
0 0.1
0.2 0.3 8,0
0.4 0.5 6,0
0.6 0.7 4,0
0.8 0.9 2,0
T 0,0
1
L
1 1 WACCn 1 1 k0 n
: 8:7
At n 1, one gets Myers formula (Myers 2001) for 1-year company, which is
particular case of BrusovFilatovaOrekhova formula (Eq. 8.7)
1 k0
WACC k0 kd wd T: 8:8
1 kd
We will study the dependence of equity cost ke on tax on profit rate T and on
leverage level L by three methods:
1. We will study the dependence of equity cost ke on tax on profit rate T at fixed
leverage level L for different lifetime (age) n of the company.
2. We will study the dependence of equity cost ke on leverage level L at fixed tax on
profit rate T for different lifetime (age) n of the company.
3. We will explore the influence of simultaneous change of leverage level L and tax
on profit rate T on equity cost ke for different lifetime (age) n of the company. In
this case, the results will be presented as 3D graphs.
In these studies, a qualitatively new effect has been discovered, and it is visible
in each of the applicable types of studies (13).
8.2.1 Dependence of Equity Cost ke on Tax on Profit Rate

T at Different Fixed Leverage Level L
Dependence of Equity Cost ke on Tax on Profit Rate T at Fixed Leverage Level

L Below we show three figures (Figs. 8.6, 8.7, and 8.8) of the dependence of equity
cost ke on tax on profit rate T at different fixed leverage L for different sets of
parameters n, k0, kd.
On the basis of the analysis of the three figures (Figs. 8.6, 8.7 and 8.8) and other
data, we come to the following conclusions:
1. All dependences are linear: equity cost decreases linearly with tax on profit rate.
2. The initial values of ke grow significantly with the level of leverage (the share of
debt capital wd) and exceed k0.
3. Lines corresponding to the different values of leverage level (the share of debt
capital wd) intersect at one point (at some value of tax on profit rate T *),
depending on parameters n, k0, kd (Figs. 8.7 and 8.8).
At fixed tax on profit rate T > T* increasing of leverage level corresponds to
moving from line 1 to 2,3, 4, and 5, i., decreasing ke; this means the discovery of
qualitatively new effect in corporative finance: decreasing of equity cost kewith
leverage. In a more obvious form, it will manifest itself in studies depending on
equity cost of the company on the leverage level, carried out by us below.
At some values of parameters n, k0, kd, the intersection of all lines at one point
could not happen at any tax on profit rate 0 < T 100 %. From the Fig. 8.9, it is
seen that with a large gap between k0 and kd, the intersection of the lines lies in the
nonexistent (nonfinancial) region T* > 100 % (for data of Fig. 8.9 T* 162 %).
8.2 Equity Cost Capital Within BrusovFilatovaOrekhova Theory 121
Fig. 8.6 Dependence of Ke Ke(T), at fix Wd

equity cost ke on tax on 0.2700
0.2500
fixed leverage levels L (n
5, k0 10 %, kd 6 %): (1) 0.2300
wd 0; (2) wd 0:2;
0.2100
(3) wd 0:4; (4) wd 0:6;
and (5) wd 0:8 0.1900
0.1700
0.1500
0.1300
0.1100
1
2
0.0900 3
4
5
0.0700
0 0.2 0.4 0.6 0.8 1 1.2
T
Fig. 8.7 Dependence of Ke Ke(T), at fixed Wd

equity cost ke on tax on 0.2000
fixed leverage levels L (n
10, k0 10 %, kd 8 %): 0.1500
(1) wd 0; (2) wd 0:2;
(3) wd 0:4; (4) wd 0:6; 0.1000 1
and (5) wd 0:8) 2
3
0.0500
4
0.0000
0 0.2 0.4 0.6 0.8 1 1.2
-0.0500
5
-0.1000
T
8.2.2 Dependence of Equity Cost ke on Leverage Level L (the

Share of Debt Capital wd) at Different Fixed Tax
on Profit Rate T
Below we show the results of calculation of dependence of equity cost ke on

leverage level L (the share of debt capital wd) in Excel at different fixed tax on
profit rate T in the form of a table, and in the form of a graph for the case
n 7, k0 20 %, kd 10 %, as well as in the form of a graph for the case n 5,
k0 10 %, kd 8 % (Table 8.1).

equity cost ke on tax on
Ke(T), at fixed Wd
0.6500
fixed leverage level L (n 0.6000
3, k0 20 %, kd 10 %): 0.5500
(1) wd 0; (2) wd 0:2;
(3) wd 0:4; (4) wd 0:6; 0.5000
and (5) wd 0:8) 0.4500
0.4000
0.3500
5
0.3000
0.2500 4
3
0.2000 2
1
0.1500
0 0.2 0.4 0.6 0.8 1 1.2
T
Fig. 8.9 Dependence of Ke Ke(L), at fixed T

equity cost ke on leverage 1.4000
level L at different tax on 1.2000 1
profit rate T (n 7, k0 20
1.0000 2
%, kd 10 %): (1) T 0;
(2) T 0:2; (3) T 0:4; (4) 0.8000 3
T 0:6; (5) T 0:8; and 0.6000 4
(6) T 1
0.4000 5
0.2000 6
0.0000
0 1 2 3 4 5 6 7 8 9 10 11
L
From Fig. 8.9, it is seen that dependence of equity cost ke on leverage level
L with a good accuracy is linear. The tilt angle decreases with tax on profit rate like
the perpetuity case.
However, for the finite lifetime (finite age) of companies along with the behavior
ke(L), similar to the perpetuity behavior of the ModiglianiMiller case (Fig. 8.9),
for some sets of parameters n, k0, kd, there is an otherwise behavior ke(L ).
From the Fig. 8.10, it is seen that starting from some values of tax on profit rate
T * (in this case, from T* 40 % , although at other sets of parameters n, k0, kd
critical values of tax on profit rate T * could be lower) there is no rise in the equity
cost of the company with leverage, but descending. Once again, the presence or the
absence of such an effect depends on a set of parameters k0, kd, n.
This effect has been observed above in the dependence of equity cost ke on tax on
profit rate T at fixed leverage level, but it is more clearly visible, depending on value
Table 8.1 Dependence of equity cost ke on leverage level L at different fixed tax on profit rates T for the case n 7, k0 20 %, kd 10 %
T/L 0.0 1.0 2.0 3.0 4.0 5.0 6.0 7.0 8.0 9.0 10
0 0.2000 0.3000 0.4000 0.5000 0.6000 0.7000 0.8000 0.9000 1.0000 1.1000 1.2000
0.2 0.2000 0.2842 0.3682 0.4522 0.5362 0.6202 0.7042 0.7874 0.8713 0.9551 1.0389
0.4 0.2000 0.2677 0.3344 0.4008 0.4672 0.5335 0.5998 0.6661 0.7323 0.7986 0.8649
0.6 0.2000 0.2504 0.2984 0.3457 0.3928 0.4397 0.4865 0.5334 0.5802 0.6265 0.6731
0.8 0.2000 0.2323 0.2601 0.2861 0.3117 0.3369 0.3619 0.3867 0.4116 0.4364 0.4612
1 0.2000 0.2132 0.2185 0.2210 0.2223 0.2229 0.2231 0.2233 0.2231 0.2228 0.2224
8.2 Equity Cost Capital Within BrusovFilatovaOrekhova Theory
123
Fig. 8.10 Dependence of Ke Ke(L), at fixed T

equity cost ke on leverage 0.4000
level L at different tax on
profit rate T (n 5, k0 10
0.3000 1
%, kd 8 %): (1) T 0; (2)
T 0:2; (3) T 0:4; (4) T
0:6; (5) T 0:8; and (6) 0.2000 2
T1
0.1000 3
0.0000 4
0 0.5 1 1.5 2 2.5 3 3.5 4 4.5 5 5.5 6 6.5 7 7.5 8 8.5 9 9.5 1010.5
-0.1000
5
-0.2000
6
-0.3000
L
of equity cost of the company on the leverage for various values of tax on profit
rate T.
Note that this is a new effect, which may take place only for the finite lifetime (finite
age) of company and which is not observed in perpetuity ModiglianiMiller limit.
It is easy to see from the ModiglianiMiller formula (8.5)
ke k0 L1 T k0 kd ;
that at T 1100 % equity cost ke does not change with leverage: ke k0 , i..,
there is no decreasing of ke with leverage at any tax on profit rate T.
8.3 Dependence of the Critical Value of Tax on Profit Rate

T * on Parameters n, k0, kd of the Company
In this section, we study the dependence of the critical value of tax on profit rate T *
on parameters n, k0, kd of the company. First, we study the dependence of the critical
value of tax on profit rate T * on the lifetime (age) of the company under variation of
the difference between k0 and kd.
The results of calculations are shown in Table 8.2 empty cells mean that the
critical value of tax on profit rate T * > 100 %, i.., we are in nonfinancial region.
The conclusions from Fig. 8.11 are as follows:
1. It is seen that the critical value of tax on profit rate T * increases with the
difference k k0 kd ; therefore, a small difference between the value of
equity cost (at L 0) k0 of the company and the credit rate kd favors the existence
of a new effect.
8.3 Dependence of the Critical Value of Tax on Profit Rate T *. . . 125
Table 8.2 The dependence of the critical value of tax on profit rate T * on the lifetime (age) of the
company under variation of the difference between k0 and kd
ke(t)/n 2 3 5 7 10 15 20 25
kd 6 %, 0.9575 0.6600 0.5200 0.4800 0.4640 0.4710 0.4903 0.5121
k0 8 %
kd 6 %, 0.9110 0.8225 0.7650 0.7332 0.7249 0.7260
k0 10 %
kd 6 %, 0.9800 0.9040 0.8693 0.8504
k0 12 %
kd 6 %, 0.9671 0.9324
k0 14 %
kd 6 %,
k0 16 %
kd 6 %,
k0 20 %
kd 6 %,
k0 24 %
Fig. 8.11 The dependence T* T*(n)

of the critical value of tax 1.0
on profit rate T * on the
lifetime (age) of the 0.9 4
company under variation of 3
the difference between 0.8
k0 and kd
(k k0 kd 2 %; 4 %; 6 0.7 2
%; 8%): (1) kd 6 %,
k0 8 %; (2) kd 6 %, 0.6
k0 10 %; (3) kd 6 %,
k0 12 %; and (4) kd 6 %, 0.5 1
k0 14 %
0.4
0.3
0.2
0.1
n
0.0
0 1 2 3 4 5 6 7 8 9 10111213141516171819202122232425
2. The critical value of tax on profit rate T * decreases monotonically with the
lifetime (age) of the company (only for 10 years in case of k k0 kd 2 % it
has a minimum). Therefore, the probability of the anomaly effect is higher for
adult companies.
3. Recapitulating 1 and 2, one can note that a small difference between the value of
equity cost (at L 0) k0 of the company and the credit rate kd as well as old
enough age of the company favors the existence of a new effect.
Table 8.3 The dependence of the critical value of tax on profit rate T * on the lifetime (age) of the
company under different values of k0 and kd at constant difference between them
k k0 kd 2 %
ke(t)/n 2 3 5 7 10 15 20 25
kd 6 %, 0.9575 0.6600 0.5200 0.4800 0.4640 0.4710 0.4903 0.5121
k0 8 %
kd 8 %, 0.7313 0.5125 0.4140 0.3905 0.3892 0.4138 0.4453 0.4803
k0 10 %
kd 10 %, 0.6000 0.4280 0.3510 0.3392 0.3467 0.3840 0.4285 0.4733
k0 12 %
kd 12 %, 0.5125 0.3687 0.3110 0.3043 0.3218 0.3697 0.4239 0.4788
k0 14 %
kd 14 %, 0.4437 0.3266 0.2810 0.2821 0.3043 0.3636 0.4277 0.4904
k0 16 %
kd 18 %, 0.3625 0.2710 0.2435 0.2549 0.2895 0.3677 0.4468 0.5221
k0 20 %
kd 22 %, 0.3100 0.2370 0.2220 0.2400 0.2875 0.3818 0.4759 0.5588
k0 24 %
We calculated as well T * at different values of k0 and kd at constant difference

between them k k0 kd 2 %. The data are shown in Table 8.3 (Fig. 8.12).
The conclusions in current case are as follows:
1. All curves are convex and the critical value of tax on profit rate T* reaches
minimum, the value of which decreases with k0.
Min T* 22.2 % at k0 24%, min T* 24.35 % at k0 20%, min
T* 28.1 % at k0 16%, min T* 30.43 % at k0 14%, min T* 33.92 %
at k0 12%, min T* 38.92 % at k0 10%, min T* 46.4 % at k0 8%.
Therefore, the higher value of k0 and the higher value of kd at constant difference
between them k k0 kd const favor the existence of a new effect.
2. The critical value of tax on profit rateT * reaches minimum at company life-
time (age), decreasing with k0: n 4:5 years at k0 24%, n 5:5 years at
k0 16%, n 6:5 years at k0 12%, and n 10:5 years at k0 8%.
3. Thus, a parallel shift up of rates k0 and kd favors a new effect, while the
companys lifetime, favorable for a new effect, decreases with k0.
Now let us investigate the dependence of critical value of tax on profit rate T *
on k0 for the second considerable case (at constant difference between k0 and kd
k k0 kd 2 %).
For this, we consider Fig. 8.13.
For companies with lifetime (age) up to 1015 years, the decreasing of critical
value of tax on profit rate T * with k0 is observed. On further increase of companys
lifetime, one observes in dependence of T * on k0 a smooth transition to a low
growing function T * on k0.
8.3 Dependence of the Critical Value of Tax on Profit Rate T *. . . 127
Fig. 8.12 The dependence T*

of the critical value of tax on
T*(n)
1.0
profit rate T * on the
1
lifetime (age) of the
company under different 0.9
values of k0 and kd at
constant difference between
0.8
them k k0 kd 2 % :
(1) k0 8 %; (2) k0 10 %; 2
(3)k0 12 %; (4)k0 14 %; 0.7
(5) k0 16 %; (6) k0 20 %;
and (7) k0 24 %
0.6 3
7
4 6
0.5 1
45
32
5
0.4
6
0.3 7
0.2
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25
n
Fig. 8.13 The dependence T*(k0)

80
T*
of the critical value of tax
on profit rate T * on k0 at
constant difference between 70
k0 and kdk k0 kd 2
%: (1) n 2; (2) n 3; (3) 60
n 5; (4) n 7; (5) n 10; 8
(6) n 15; (7) n 20; and 50
(8) n 25 7
40
6
1
30
5
2
4
20 3
10
k0
0
9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25
So, for companies with lifetime (age) up to 1015 years, monotonic growth of k0
favors a new effect, while for companies with longer lifetime rates of order k0 12
15 % favor a new effect.
8.4 Practical Value of Effect
What is the practical value of effect? Does it exist in real life or its discovery has a
purely theoretical interest?
Because a new effect takes place at tax on profit rate, which exceeds some value
T*, it is necessary to compare this value with real tax on profit rates established in
the different countries.
The biggest tax on profit rate for corporation is in USA39.2 %. In Japan, it
exceeds a little bit, 38 %. In France, tax on profit rate varies from 33.3 % for small
and medium-sized companies, up to 36 % for the major. In England, tax on profit
rate is in the range of 2128 %. In the Russian Federation, tax on profit rate amounts
to 20 %.
In the examples considered by us, the value of T* strongly depends on the ratio
between k0, kd, n and reaches a minimal value of 22.2 %, and it is quite likely for
even lower values of T* with other ratios of values k0, kd, n.
In this way, we come to the conclusion that at some ratios of values of equity
cost, debt cost, and companys lifetime (age) k0, kd, n the effect discovered by us
takes place at tax on profit rate established in most developed countries, which
provides the practical value of the effect.
Taking it into account is important in improving tax legislation and may change
dividend policies of the company.
Opening the effect expands our view of the rules of the game in the economy.
If prior to that it was widely known that with the rising of leverage the equity
cost is always growing, which is associated with the decrease of financial sustain-
ability of the companies, with an increase in the share of borrowing, then the
shareholders require a higher rate of return on the share.
But now it becomes clear that this is not always the case, and the dependence of
equity cost on leverage depends on the ratio between the parameters k0, kd, n and,
ultimately, on the tax on profit rate.
This effect has never been known; therefore, it was not taken into account by
controls tax legislation, but opportunities here are tremendous.
The effect is also important for the development of the dividend policy of the
company.
It turns out that the rule taken by the shareholders since time immemorialto
require higher rate of return on the share with an increase of the portion of debt
capitalnow does not always work. This will allow the company management to
hold a more realistic dividend policy, limiting appetites of shareholders by eco-
nomically founded value of dividends.
8.5 Equity Cost of 1-Year Company 129
8.5 Equity Cost of 1-Year Company
The dependence of the equity cost on tax on profit rate T for 1-year company has
some features, considered below. Interest in the 1-year companies is associated also
with the fact that a great number of companies, both in developed countries and in
developing ones, are becoming bankrupt or no longer exist in the first year or two
after the creation.
For 1-year company, the BrusovFilatovaOrekhova (BFO) equation for
weighted average cost of capital is simplified and can be expressed in apparent
form (Brusov and Filatova 2011; Brusov et al. 2011a, b, c, 2012a, b, 2013a, b,
2014a, b; Filatova et al. 2008) (Eq. 8.8)
1 k0
WACC k0 kd wd T:
1 kd
This formula has been obtained for the first time by Myers (2001) and represents the
particular case of the BrusovFilatovaOrekhova (BFO) equation at n 1.
By definition, for weighted average cost of capital with accounting for the tax
shield, one has
WACC ke we kd wd 1 T : 8:9
Substituting here the expression for WACC of 1-year company, let us find the
expression for equity cost ke of the company

WACC wd kd 1 T kd
ke k 0 L k 0 k d 1 T : 8:10
we 1 kd
It is seen that equity cost ke decreases linearly with tax on profit rate. The module of
negative tilt angle tangent is equal to
kd
tg Lk0 kd 8:11
1 kd
However, the calculation for the case k0 10 %, kd 8 % gives practically

independence of equity cost ke of the companys tax on profit rate T at fixed
leverage level (Fig. 8.14).
This is due to the low value of coefficient k0 kd 1k
kd
d
, which in our case is
equal to 0.00148. Therefore, descending becomes visible only at significantly
higher leverage (Fig. 8.14).
Note that such a weak dependence (virtually independence) of equity cost ke of
the company on tax on profit rate T at fixed leverage level takes place for 1-year
company only.
Fig. 8.14 Dependence of Ke (T) Ke

rate T at fixed leverage level 5 0.2500
for 1-year company (n 1, 4 0.2000
k0 10 %, kd 8 %)
3
0.1500
2
1 0.1000
0.0500
0.0000
0 0.2 0.4 0.6 0.8 1 1.2
T
Already for 2-year company with the same parameters, dependence of equity
cost ke of the company on tax on profit rate T at fixed leverage level becomes
significant.
Below we give an example for 2-year company with other parameters
n 2, k0 24 %, kd 22 % (Fig. 8.15).
Finding a formula for T*
In case of 1-year company, it is easy to find a formula for T*.
Putting in (Eq. 8.10) ke k0 , one gets

kd
k 0 k 0 L k 0 k d 1 T 8:12
1 kd
From where
1 kd
T* 8:13
kd
It is seen that T * does not depend on L, i.., all the direct lines, corresponding to
different L, intersect at a single point. From the data for the older companies
(n > 1 year), it follows that similar situation takes place for them as well; however,
it becomes more difficult to prove this fact and in case n > 3, practically
impossible.
Note that Eq. (8.13) allows us to evaluate the value of T *, which depends now on
credit rate only and is equal to:
for kd 8% T* 13:5
for kd 10 % T* 11
for kd 15 % T* 7:7
for kd 25 % T* 5
8.5 Equity Cost of 1-Year Company 131
Fig. 8.15 Dependence of Ke (t), n = 2, Kd = 22%, K0 = 24% Ke

rate T at fixed leverage level
for 2-year company (n 2, 0.3000
k0 24 %, kd 22 %)
0.2000
0.1000
0.0000
0.0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1.0 1.1
-0.1000
-0.2000
T
for kd 100 % T* 2
It is clear that for all (reasonable and unreasonable) credit rate values, tax on profit
rate T* is situated in nonfinancial region (which exceeds 1 (100 %)), which is the
cause of the absence of effect.
Analysis of the formula (Eq. 8.13) shows that at very large credit rate values T,
T* tends to be 1(100 %), always remaining greater than 1. This means that the effect
found by us is absent for 1-year company.
Let us show the 3D picture for dependence of equity cost ke of the company on
tax on profit rate T and leverage level L for 1-year company (Fig. 8.16).
It is seen that all dependences of equity cost ke of the company on tax on profit
rate T and leverage level L are linear, and abnormal effect for 1-year company
(as well as for perpetuity one) is absent.
Conclusions Qualitatively new effect in corporative finance is discovered: decreas-
ing of equity cost ke with leverage L. This effect, which is absent in perpetuity
ModiglianiMiller limit, takes place on account of finite lifetime (finite age) of the
company at tax on profit rate, which exceeds some value T* (Brusov and Filatova
At some ratios between debt cost and equity cost, the discovered effect takes
place at tax on profit rate, existing in Western countries and Russia. This provides
the practical meaning of discovered effect. Taking it into account is important for
the modification of tax law and can change the dividend policy of the company.
In this chapter, the complete and detailed investigation of discussed effect,
discovered within BrusovFilatovaOrekhova (BFO) theory, has been done
(Brusov and Filatova 2011; Brusov et al. 2011a, b, c, 2012a, b, 2013a, b, 2014a,
b; Filatova et al. 2008). It has been shown that the absence of the effect at some
Ke(t,L) for n = 1
Ke
0.3000
0.2500
0.2000
0.1500
0.2500-
0.3000
0.2000-
0.2500
0.1000 0.1500-
0.2000
0.1000-
0.1500
0.0500 0.0500-
0.1000
0.0000-
0.0500
0.0000 8
6
0 0.2 4
0.4 0.6 2
0.8 1
0 L
T
Fig. 8.16 Dependence of equity cost ke of the company on tax on profit rate T and leverage level
L (n 1, k0 10 %, kd 8 %)
particular set of parameters is connected to the fact that in these cases, T* exceeds
100 % (tax on profit rate is situated in a nonfinancial region).
In future, the papers and monographs will be devoted to discussion of discovered
abnormal effect, but it is already clear now that we will have to abandon some of the
established views in corporative finance.
References
(11):815824
2:1621
References 133

abnormal dependence of equity cost of company on leverage. J Rev Global Econ 2:183193
http://dx.doi.org/10.1080/23322039.2014.946150
Econ Rev 53:147175
19541957. Am Econ Rev 56:333391
Chapter 9
Inflation in BrusovFilatovaOrekhova
Theory and in Its Perpetuity Limit
ModiglianiMiller Theory
In this chapter, the influence of inflation on capital cost and capitalization of the
company within modern theory of capital cost and capital structureBrusov
FilatovaOrekhova theory (BFO theory) (Brusov and Filatova 2011; Brusov
et al. 2011a, b, c, 2012a, b, 2013a, b, 2014a, b; Filatova et al. 2008; Brusova
2011) and within its perpetuity limitModiglianiMiller theory (odigliani and
iller 1958, 1963, 1966) is investigated. By direct incorporation of inflation into
both theories, it is shown for the first time that inflation not only increases the equity
cost and the weighted average cost of capital, but as well it changes their depen-
dence on leverage. In particular, it increases the growing rate of equity cost with
leverage. Capitalization of the company is decreased under inflation (Fig. 9.1).
Introduction Created more than half a century ago by Nobel Prize winners
Modigliani and Miller, theory of capital cost and capital structure (odigliani
and iller 1958, 1963, 1966) did not take into account a lot of factors of a real
economy, such as taxing, bankruptcy, unperfected capital markets, inflation, and
many others. But while taxes have been included into consideration by authors
themselves and some other limitations have been taken off by their followers, direct
incorporation of inflation to ModiglianiMiller theory was absent still now.
In this chapter, the influence of inflation on valuation of capital cost of company
and its capitalization is investigated within ModiglianiMiller theory ()
(odigliani and iller 1958, 1963, 1966), which is now outdated but still widely
used in the West, as well as within modern theory of capital cost and capital
structureBrusovFilatovaOrekhova theory (BFO theory) (Brusov and Filatova
2011; Brusov et al. 2011a, b, c, 2012a, b, 2013a, b, 2014a, b; Filatova et al. 2008),
which should replace ModiglianiMiller theory (odigliani and iller 1958, 1963,
1966). It is shown that inflation not only increases the equity cost and the weighted
average cost of capital, but as well it changes their dependence on leverage. In
particular, it increases growing rate of equity cost with leverage. Capitalization of
the company is decreased under inflation.

DOI 10.1007/978-3-319-14732-1_9
136 9 Inflation in BrusovFilatovaOrekhova Theory and in Its Perpetuity. . .

equity cost and the weighted
average cost of capital on
leverage in the Modigliani
Miller theory without taxing
under inflation. It is seen
that growing rate of equity
cost increases with
leverage. Axis y means
capital costsCC
We start from the study of inflation within ModiglianiMiller theory without

taxes (odigliani and iller 1958), then with taxes (Modigliani et al. 1963), and
finally within modern theory of capital cost and capital structureBrusov
FilatovaOrekhova theory (BFO theory) (Brusov and Filatova 2011; Brusov
et al. 2011a, b, c, 2012a, b, 2013a, b, 2014a, b; Filatova et al. 2008).

Without Taxes
Note that any modification of ModiglianiMiller theory, as well as of any other one,
requires going beyond the frame of modifying theory. Thus, in current case, we
should go beyond the frame of perpetuity of the company (to remind the reader that
ModiglianiMiller theory describes only perpetuity companiescompanies with
infinite lifetime), consider the companies with finite lifetime, make necessary
calculations, and then use the perpetuity limit.
As known, in profit approach, capitalization of the company is equal to
discounted sum of profits of the company. Suppose that profit is constant for all
periods and equal to CF, one gets for capitalization of the financially independent
company V0 , existing n years at market,
9.1 Accounting of Inflation in ModiglianiMiller Theory Without Taxes 137
CF CF CF
V0 ; 9:1
1 k 0 1 k 0 2 1 k 0 n
where k0 is the capital cost of the financially independent company.

Under inflation with rate , the capitalization of the financially independent
company V0 becomes equal to
CF CF CF
V *0 : 9:2
1 k0 1 1 k0 1 2 1 k0 1 n
Using the formula for sum of the terms of indefinitely diminishing geometrical
progression with the first term
CF
a1 9:3
1 k0 1
and denominator
1
q ; 9:4
1 k0 1
one gets for capitalization of the financially independent company V0 , the following
expression:
a1 CF
V *0 h i
1 q 1 k0 1 1 1 k0 1 1
CF CF
:
1 k 0 1 1 k 0 1
CF
V *0 : 9:5
k0 1
It is seen that under inflation, the capitalization of the company decreases.

At discount rate k0 10 % and inflation rate 3 %, the decrease is equal to
5.7 %, and at discount rate k0 15 % and inflation rate 7 %, the decrease is
equal to 35 %. One can see that influence of inflation on the company capitalization
could be significant enough and is always negative.
For leverage company (using debt capital) capitalization, one has without
inflation
CF CF CF
VL 9:6
1 WACC 1 WACC2 1 WACCn
and in perpetuity limit,

CF
VL : 9:7
WACC
Under inflation, the capitalization of the company is equal to
CF CF
V *L
1 WACC1 1 WACC1 2
9:8
CF
:
1 WACC1 n
Summing the infinite set, we get for leverage company capitalization under infla-
tion in ModiglianiMiller limit
a1 CF
V *L h i
1 q 1 WACC1 1 1 WACC1 1
CF CF
;
1 WACC1 1 WACC1
CF
V *L : 9:9
WACC1
It is seen that similar to the case of the financially independent company,

inflation decreases the company capitalization, and the decrease could be signifi-
cant. From the formulas (Eq. 9.7) and (Eq. 9.9), it follows that effective values of
capital costs (equity cost and WACC) are equal to:
k*0 k0 1 ; 9:10
WACC WACC 1 :
*
9:11
Note that both capital costs increase under inflation.

We can compare obtained results with Fisher formula for inflation.
i
i* : 9:12
1
Solving this equation with respect to nominal rate i, one gets equation, similar to
(Eq. 9.10) and (Eq. 9.11),
i i* 1 : 9:13
Thus, effective capital costs in our case have meaning of nominal ones, account-
ing inflation.
9.1 Accounting of Inflation in ModiglianiMiller Theory Without Taxes 139
From the ModiglianiMiller theorem, that the weighted average cost of capital
WACC does not depend on leverage level (without taxing), formulating under
inflation, it is easy to get expression for the equity cost:
WACC* k*0 k*e we k*d wd : 9:14
Finding from here ke , one gets:
k*0 wd k* S D D D
k*e k*d 0 k*d k*0 k*0 k*d
we we S S S
*
k0 k0 kd L
* *
9:15
Putting instead of k0 , kd in their expressions, one gets finally

k*e k*0 k*0 k*d L k0 1
Lk0 kd 1 1 k0 Lk0 kd
k*e k0 1 Lk0 kd 1 : 9:16
It is seen that inflation not only increases the equity cost, but as well it changes its
dependence on leverage. In particular, it increases growing rate of equity cost with
leverage by multiplier (1+ ). The growing rate of equity cost with leverage, which
is equal to k0 kd without inflation, becomes equal to k0 kd 1 with
accounting of inflation.
Thus, we come to the conclusion that it is necessary to modify the second
statement of the ModiglianiMiller theory (odigliani and iller 1958)
concerning the equity cost of leverage company.
Second Original MM Statement
Equity cost of leverage company ke could be found as equity cost of financially
independent company k0 of the same group of risk, plus premium for risk, the
value of which is equal to production of difference k0 kd on leverage level L.
Second Modified MM-BFO Statement
Under existence of inflation with rate , equity cost of leverage company ke
could be found as equity cost of financially independent company k0 of the
same group of risk, multiplied by (1+ ), plus inflation rate and plus
premium for risk, the value of which is equal to production of difference
k0 kd on leverage level L and on multiplier 1 .

with Corporate Taxes
Let us calculate first the tax shield for perpetuity company under inflation
X
1 t
PVTS k*d DT 1k*d DT : 9:17
t1
It is interesting to note that in spite of dependence of each term of set on effective

credit rate
kd , tax shield turns out to be independent of it and equal to inflationless value
D, and ModiglianiMiller theorem under inflation takes the following form
(odigliani and iller 1963):
V *L V *0 DT: 9:18
Substituting D wd V *L ,
one gets
V *L CF=k*0 wd V *L T 9:19
or
V *L 1 wd T CF=k*0 : 9:20
Because leverage company capitalization is equal to

V *L CF=WACC* , for the weighted average cost of capital, one has
WACC* k*0 1 wd T : 9:21
From (Eq. 9.21), we get the dependence of WACC* on leverage level L D=S:
WACC* k*0 1 LT=1 L ;

WACC* k0 1 1 wd T : 9:22
On definition of the weighted average cost of capital with accounting of the tax
shield, one has
WACC* k*0 we k*d wd 1 T : 9:23
Equating right-hand parts of expressions (Eq. 9.21) and (Eq. 9.23), we get
9.2 Accounting of Inflation in ModiglianiMiller Theory with Corporate Taxes 141
k*0 1 wd T k*0 we k*d wd 1 T ; 9:24
from where one obtains the following expression for equity cost:
1 wd T wd 1 wd D
k*e k*0 k*d 1 T k*e k*0 T k*d 1 T
we we we we S
D S D D
k*0 k*0 T k*d 1 T k*0 L1 T k*0 k*d ;
S S S
*
ke k0 L1 T k0 k*d
* *
k0 1 L1 T k0 kd 1 : 9:25
It is seen that similar to the case without taxes, inflation not only increases the
equity cost, but as well it changes its dependence on leverage (Fig. 9.2). In
particular, it increases growing rate of equity cost with leverage by multiplier (1+
). The growing rate of equity cost with leverage, which is equal to k0 kd
1 T without inflation, becomes equal to k0 kd 1 1 T with account-
ing of inflation.
We can now reformulate the fourth statement of the ModiglianiMiller theory
(odigliani and iller 1963) concerning the equity cost of leverage company for
case of accounting of inflation.

equity cost and the weighted
average cost of capital on
leverage in the Modigliani
Miller theory with taxes
under inflation. It is seen
that growing rate of equity
cost increases with
leverage. Axis y means
capital costsCC
Fourth Original MM Statement

Equity cost of leverage company ke paying tax on profit could be found as
equity cost of financially independent company k0 of the same group of risk,
plus premium for risk, the value of which is equal to production of difference
k0 kd on leverage level L and on tax shield (1-T) and on multiplier 1 .
Fourth Modified MM-BFO Statement
Equity cost of leverage company ke paying tax on profit under existence of
inflation with rate could be found as equity cost of financially independent
company k0 of the same group of risk, multiplied by 1 , plus inflation rate
and plus premium for risk, the value of which is equal to production of
difference k0 kd on leverage level L, on tax shield (1 T) and on multiplier
1 .
9.3 Accounting of Inflation in BrusovFilatovaOrekhova

Theory with Corporate Taxes
9.3.1 Generalized BrusovFilatovaOrekhova Theorem
BrusovFilatovaOrekhova generalized the ModiglianiMiller theory for the case

of the companies with arbitrary lifetime (of arbitrary age) (Brusov and Filatova
2011; Brusov et al. 2011a, b, c, 2012a, b, 2013a, b, 2014a, b; Filatova et al. 2008)
and have proved the following important theorem in case of absence of corporate
taxing:
Without corporate taxing, the equity cost k0, as well as the weighted average
cost of capital WACC, does not depend on companys lifetime and is equal to
k e k 0 L k 0 k d and WACC k0 : 9:26
consequently.
Thus, the theorem has proved that without corporate taxes (say, in offshore
zones), the ModiglianiMiller results for capital costs, in spite of the fact that they
have been obtained in perpetuity limit, remain in force for companies with arbitrary
lifetime, described by BrusovFilatovaOrekhova theory (BFO theory). To prove
this theorem, Brusov, Filatova, and Orekhova, of course, had to go beyond
ModiglianiMiller approximation.
Under inflation, we can generalize this theorem (Brusov and Filatova 2011;
Brusov et al. 2011a, b, c, 2012a, b, 2013a, b, 2014a, b; Filatova et al. 2008):
Generalized BrusovFilatovaOrekhova Theorem
Under inflation without corporate taxing, the equity cost k0 , as well as the
weighted average cost of capital WACC*, does not depend on companys lifetime
and is equal to
9.4 Generalized BrusovFilatovaOrekhova Formula Under Existence of Inflation 143

k*e k*0 L k*0 k*d k0 1 Lk0 kd 1
and
WACC* k*0 k0 1 9:27
consequently.
Following BrusovFilatovaOrekhova (Brusov and Filatova 2011; Brusov
et al. 2011a, b, c, 2012a, b, 2013a, b, 2014a, b; Filatova et al. 2008), let us consider
the situation for arbitrary lifetime companies with accounting of corporate taxing.
They have derived the famous formula for weighted average cost of capital of
companies with arbitrary lifetime
1 1 WACCn 1 1 k0 n
: 9:28
The application of BFO formula (9.28) is very wide: authors have applied it in
corporate finance, in investments, in taxing, in business valuation, in banking,
and in some other areas (Brusov et al. 2011a, b, 2013a). Using this formula (9.28),
one can study the dependence of the weighted average cost of capital, WACC, as
well as the equity cost, ke, on leverage level, L, on tax on profit rate, t, on lifetime
of the company, n, and on relation between equity and debt cost. The qualitatively
new effect in corporate finance has been discovered: decrease of the equity cost ke
with leverage level L, which is quite important for corporate finance in general
and, in particular, for creating the adequate dividend policy.
Below we generalize formula (9.28) under existence of inflation.
9.4 Generalized BrusovFilatovaOrekhova Formula

Under Existence of Inflation
Under existence of inflation, it is necessary to replace all capital costs: the equity,
the debt, and the weighted average cost of capital k0, kd, WACC by effective ones
k0 , kd , WACC*,
where
k*0 k0 1 ;
k*d kd 1 ;
WACC* WACC 1 :
Rewriting the equations for tax shield (TS)n, capitalization of financially inde-
pendent company V0 , as well as for financially dependent company VL for the case
of existence of inflation, one gets
X
n t n
PVTS TSn k*d DT 1k*d DT 1 1 k*d 9:29
t1
X
n t n *
V *0 CF 1k*0 CF 1 1 k*0 =k0 ; 9:30
t1
Xn n
V *L CF 1WACC* t CF 1 1 WACC* =WACC* ; 9:31
t1
V *L V *0 TSn : 9:32
After substitution D wd V *L we have
V *L CF=k*0 wd V *L T: 9:33
From here, after some transformations we get generalized BrusovFilatova

Orekhova formula under existence of inflation
n n
1 1 WACC* 1 1 k*0
* n ; 9:34
WACC* k0 1 d T 1 1 k*d
or after substitutions,
k*0 k0 1 ; k*d kd 1 ;
one gets finally

n
1 1 WACC* 1 1 k0 1 n
:
WACC* k0 1 1 d T 1 1 kd 1 n
9:35
Formula (9.35) is the generalized BrusovFilatovaOrekhova formula under exis-

tence of inflation.
Let us show some figures, illustrating obtained results.
In Figs. 9.3 and 9.4, the dependence of the weighted average cost of capital
WACC on debt fraction wd at different inflation rate (1, 3 %; 2, 5 %; 3,
7 %; 4, 9 %) for 5-year company as well as for 2-year company is seen. It is
seen that with increase of inflation rate lines, showing the dependence, WACC (wd)
shift practically homogeneously to higher values.

weighted average cost of WACC WACC(wd), k0=20%, kd=12%, T=20%
0.35
capital WACC on debt
fraction wd at different
inflation rate (1, 3 %; 0.30
2, 5 %; 3, 7 %; and
4, 9 %) for 5-year
company 0.25
4
3
0.20 2
1
0.15
0.10
0.05
Wd
0.00
0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1 1.1

WACC WACC(wd), k0=20%, kd=12%, T=20%
0.35
fraction wd at different
0.30
inflation rate (1, 3 %;
2, 5 %; 3, 7 %; and
4, 9 %) for 2-year 0.25 4
company 3
2
0.20
1
0.15
0.10
0.05
Wd
0.00
0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1 1.1
It is seen that difference in results for 2-year company and 5-year company is
very small. More obviously, it could be observed from below tables (Tables 9.1 and
9.2).
Below we show the dependences of the weighted average cost of capital
WACC on debt fraction wd at different tax on profit rate from T 10 % up to
T 100 % at different inflation rate 3 %, 5 %, 7 %, and 9 % for 5-year company
146
Table 9.1 Dependence of the weighted average cost of capital WACC on debt fraction wd at different inflation rate 3 %; 5 %; 7 %; and 9 % for 2-year
company
/wd 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1
0.03 0.2318 0.2276 0.2233 0.2191 0.2149 0.2106 0.2064 0.2021 0.1979 0.1937
0.05 0.2557 0.2503 0.2455 0.2406 0.2358 0.2309 0.2261 0.2212 0.2164 0.2115
0.07 0.2786 0.2733 0.2679 0.2626 0.2573 0.2514 0.2459 0.2404 0.2350 0.2295
0.09 0.3020 0.2960 0.2900 0.2839 0.2779 0.2720 0.2661 0.2602 0.2537 0.2476
9 Inflation in BrusovFilatovaOrekhova Theory and in Its Perpetuity. . .
Table 9.2 Dependence of the weighted average cost of capital WACC on debt fraction wd at different inflation rate 3 %; 5 %; 7 %; and 9 % for 5-year
company
/wd 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1
0.03 0.2311 0.2262 0.2213 0.2163 0.2113 0.2064 0.2013 0.1963 0.1912 0.1863
0.05 0.2546 0.2491 0.2434 0.2379 0.2323 0.2267 0.2210 0.2154 0.2097 0.2040
0.07 0.2781 0.2718 0.2657 0.2595 0.2534 0.2472 0.2408 0.2346 0.2283 0.2219
0.09 0.3015 0.2947 0.2879 0.2812 0.2744 0.2676 0.2608 0.2539 0.2471 0.2400
9.4 Generalized BrusovFilatovaOrekhova Formula Under Existence of Inflation
147

WACC WACC(wd), k0=20%, kd=12%,
0.35
capital WACC on debt a =3%
fraction wd at different tax
on profit rate at inflation rate 0.25
3 % for 5-year
company. Tax on profit rate
increases from T 0.1
0.15
(upper line) up to T 1
(lower line) with step 0.1
0.05
0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1 1.1
-0.05
-0.15
Wd

WACC WACC(wd), k0=20%, kd=12%,
0.35
5 % for 5-year
increases from T 0.1 0.15
0.05
0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1 1.1
-0.05
-0.15
Wd
(Figs. 9.5, 9.6, 9.7, and 9.8) as well as for 2-year company (Figs. 9.9, 9.10, 9.11, and
9.12). Tax on profit rate increases from T 0.1 (upper line) up to T 1 (lower line)
with the step 0.1.
The analysis of Figs. 9.5, 9.6, 9.7, 9.8, 9.9, 9.10, 9.11, and 9.12 shows that the
weighted average cost of capital WACC decreases with debt fraction wd and faster
with increase of tax on profit rate. The space between lines, corresponding to
different tax on profit rates, increases with inflation rate. The variation range of
WACC increases with inflation rate as well as with lifetime of the company.
Fig. 9.7 Dependence of the WACC WACC(wd), k0=20%, kd=12%,

capital WACC on debt =7%
on profit rate at inflation rate
7 % for 5-year 0.15
increases from T 0.1 0.05 Wd
(lower line) with step 0.1 -0.05 0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1 1.1
-0.15
Fig. 9.8 Dependence of the WACC

WACC(wd), k0=20%, kd=12%,
0.30 a = 9%
9 % for 5-year
0.20
(upper line) up to T 1 0.10
0.05 Wd
0.00
0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1 1.1
-0.05
-0.10
-0.15
Fig. 9.9 Dependence of the WACC WACC(wd), k0=20%, kd=12%,

3 % for 2-year 0.25
0.15
0.10
0.05
Wd
0.00
0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1 1.1
-0.05

the weighted average cost of WACC(wd), k0=20%, kd=12%,
0.35
0.25
5 % for 2-year
company. Tax on profit rate 0.15
0.05 Wd
-0.05 0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1 1.1

the weighted average cost of 0.35
WACC(wd), k0=20%, kd=12%,
0.25
7 % for 2-year
0.10
0.05
Wd
0.00
0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1 1.1
-0.05

the weighted average cost of 0.35
WACC(wd), k0=20%, kd=12%,
0.25
9 % for 2-year
0.10
0.05
Wd
0.00
0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1 1.1
-0.05
9.6 Inflation Rate for a Few Periods 151
9.5 Irregular Inflation
Above we considered inflation rate as constant. Really, as a rule, the inflation rate is
a variable. It is possible to generalize all above considerations for the case of
nonhomogeneous inflation, introducing effective inflation for a few periods.
The effective inflation rate for a few periods t t1 t2 tn is equal to
1 1 1 2 . . . 1 n 1; 9:36
where 1, 2, . . ., n are inflation rates for periods t1, t2, . . ., tn.

The proof of the formula (9.36) will be done below in Sect. 9.6.
In the case of nonhomogeneous inflation, it could be accounted in both theories:
ModiglianiMiller and BrusovFilatovaOrekhova theory (BFO theory) either
through effective inflation rate or directly upon discounting of financial flow.
9.6 Inflation Rate for a Few Periods
Suppose that the inflation rate for the consistent time periods t1, t2, . . ., tn is equal to
1, 2, . . ., n consequently. Let us find the inflation rate for total time period
t t1 t2 tn .
Common sense dictates that inflation rate is an additive value, so that , at least
approximately, is equal to the sum of the inflation rates 1, 2, . . ., n
1 2 n : 9:37
Below we will get an exact expression for inflation rate for the total period of
time, t, and will see how it is different from an intuitive result (9.37).
At the end of the first commitment period, the gained sum will be equal
to the amount S1 S0 1 i, and with accounting of inflation, S1
S0 1 it1 =1 1 . At the end of the second commitment period, the gained
sum will be equal to the amount S2 S0 1 it1 t2 , and with accounting of
inflation, S2 S0 1 it1 t2 =1 1 1 2 . At the end of the nth commitment
period, the gained sum will be equal to the amount Sn S0 1 it1 t2 ...tn , and
with accounting of inflation,
Sn S0 1 it1 t2 ...tn =1 1 1 2 . . . 1 n : 9:38
On the other hand, at inflation rate for the total period at t t1 t2 tn

at the end of this period t, gained sum will be equal to
Sn S0 1 it =1 : 9:39
Equating the right-hand part of (9.38 ) and (9.39), we get
1 1 1 2 . . . 1 n 1 : 9:40
From where,
1 1 1 2 . . . 1 n 1: 9:41
It is easy to get a strict proof of this formula by the method of mathematical

induction. Note that inflation rate for the n-periods does not depend on both the
length of constituting periods and on the period t.
For equal inflation rates 1 2 n (it is interesting to note that
herewith the time intervals t1, t2, . . ., tn can be arbitrary and do not equal each
other), one has
1 1 n 1: 9:42
Conclusions In this chapter, the influence of inflation on capital cost and capital-
ization of the company within modern theory of capital cost and capital structure
BrusovFilatovaOrekhova theory (BFO theory) (Brusov and Filatova 2011;
Brusov et al. 2011a, b, c, 2012a, b, 2013a, b, 2014a, b; Filatova et al. 2008) and
in its perpetuity limitModiglianiMiller theory (odigliani and iller 1958,
1963, 1966), which is now outdated, but still widely used in the West, is investi-
gated. All basic results of ModiglianiMiller theory were modified. It is shown that
inflation not only increases the equity cost and the weighted average cost of capital,
but as well it changes their dependence on leverage. In particular, it increases the
growt rate of equity cost with leverage. Capitalization of the company is decreased
with accounting of inflation.
Within modern theory of capital cost and capital structureBrusovFilatova
Orekhova theory (BFO theory), the modified equation for the weighted average
cost of capital, WACC, applicable to companies with arbitrary lifetime under
inflation has been derived. Modified BFO equation allows us to investigate the
dependence of the weighted average cost of capital, WACC, and equity cost, ke, on
leverage level, L, on tax on profit rate, t, on lifetime of the company, n, on equity
cost of financially independent company, k0, and debt cost, kd, as well as on
inflation rate .
Using modified BFO equation, the analysis of the dependence of the weighted
average cost of capital WACC, on debt fraction, wd, at different tax on profit rate t,
as well as inflation rate has been done.
It has been shown that WACC decreases with debt fraction, wd, and faster at
bigger tax on profit rates t. The space between lines, corresponding to different
values of tax on profit rate at the same step (10 %), increases with inflation rate .
The variation region (with change of tax on profit rate t) of the weighted average
cost of capital, WACC, increases with inflation rate , as well as with lifetime of the
company n.
References 153
References
(11):815824
2:1621
http://dx.doi.org/10.1080/23322039.2014.946150
Econ Rev 53:147175
Modigliani F, Miller M (1966) Some estimates of the Cost of Capital to the Electric Utility
Industry 19541957. Am Econ Rev 56:333391
Part II
Investments
Next chapters (Chaps. 1017) are devoted to study of different problems of

investments: dependence of efficiency of investments on debt financing, on tax
on profit rate, on investment capital structure (leverage level); the existence of
optimal investment capital structure etc. We will present a different investment
models, developed by us and will study mentioned above problems using these
models. We start from the portfolio analysis in its simplest form: we study in this
chapter (Chap. 10) a portfolio of two securities.
Chapter 10
A Portfolio of Two Securities
The main objective of any investor is to ensure the maximum return on investment.
During the realization of this goal, at least two major problems appear: the first, in
which of the available assets and in what proportions investor should invest. The
second problem is related to the fact that, in practice, as is well known, a higher
level profitability is associated with a higher risk. Therefore, an investor can select
an asset with a high yield and high risk or a more or less guaranteed low yield.
These two selection problems constitute a problem of investment portfolio forma-
tion, the decision which is given by portfolio theory, described in this chapter. We
study in detail the portfolio of the two securities (Brusov and Filatova 2014; Brusov
et al. 2010, 2012), which represents a more simple case, containing, however, all
the main features of more common Markowitz and Tobin portfolios. It appears that
when selecting anticorrelated or noncorrelated securities, you can create a portfolio
with the risk lower than the risk of any of the securities of portfolio, or even zero-
risk portfolio (for anticorrelated securities).
10.1 A Portfolio of Two Securities
10.1.1 A Case of Complete Correlation
In a case of complete correlation,
12 1: 10:1
For the square of the portfolio risk (dispersion), we have

DOI 10.1007/978-3-319-14732-1_10
158 10 A Portfolio of Two Securities
2 21 x21 22 x22 212 1 2 x1 x2 21 x21 22 x22 2 1 2 x1 x2

1 x 1 2 x 2 2 : 10:2
Extracting the square root from both sides, we obtain for portfolio risk
j 1 x1 2 x2 j: 10:3
Since all variables are nonnegative, the sign of the module can be omitted
1 x1 2 x2 : 10:4
Substituting x1 ! 1 t; x2 ! t, accounting x1 x2 1, we get,
1 1 t 2 t: 10:5
This is the equation of the segment (A), where points A and B have the following
coordinates: A 1 ; 1 ; B 2 ; 2 . t runs from 0 to 1. At t 0, portfolio is
at point A, and at t 1at the point B. Thus, the admissible set of portfolios in the
case of complete correlation of the securities is a segment (AB) (Fig. 10.1).
If an investor forms a portfolio of minimal risk, he must incorporate in it one
type of paper that has less risk, in this case, the paper A, and the portfolio in this case
is X 1; 0. Portfolio yield (effectiveness) 1 .
With a portfolio of maximum yield, it is necessary to include in it only securities
with higher income, in this case, the paper B, and the portfolio in this case is
X 0; 1. Portfolio yield 2 .

of the risk of the portfolio of
two securities on its
effectiveness for fixed
parameters of both
securities and with increase
in the correlation coefficient
from 1 to 1
10.1 A Portfolio of Two Securities 159
10.1.2 Case of Complete Anticorrelation
In the case of complete anticorrelation,
12 1: 10:6
For the square of the portfolio risk (dispersion), we have
2 21 x21 22 x22 212 1 2 x1 x2 21 x21 22 x22 2 1 2 x1 x2

1 x 1 2 x 2 2 : 10:7
Extracting the square root of both sides, we obtain for portfolio risk
j 1 x1 2 x2 j: 10:8
Admissible set of portfolios in the case of complete anticorrelation of securities

consists of two segments (A, ) and (, ) (Fig. 10.1). In this case, a risk-free
portfolio (point C) can exist.
Let us find a risk-free portfolio and its profitability.
From (10.8), one has
1 x1 2 x2 0: 10:9
Substituting in (10.9) x2 1 x1 , we get
1 x1 2 1 x1 0;
2
x1 : 10:10
1 2
And
2
x2 1 x1 : 10:11
1 2
Thus, risk-free portfolio has the form

2 1
X ; ; 10:12
1 2 1 2
and its yield is equal to
1 2 2 1
0 : 10:13
1 2
Note that the risk-free portfolio does not depend on the yield of securities and is
determined solely by their risks, and the pricing share of one security is proportional
to the risk of
another.
Since 1, then, all admissible portfolios are located inside

( < 1), or on the boundary ( 1), of the triangle ABC (Fig. 10.1).
Example 10.1
For a portfolio of two securities with yield and risk, respectively, (0.2; 0.5) and
(0.4; 0.7) in the case of complete anticorrelation found risk-free portfolio and its
profitability.
First, using the formula (4.30), we find a risk-free portfolio

2 1 0:7 0:5
X0 ; ; 0:583; 0:417:
1 2 1 2 0:5 0:7 0:5 0:7
Then by the formula (4.31), we find its yield
1 2 2 1 0:2 0:7 0:4 0:5

0 0:283:
1 2 0:5 0:7
It is seen that the portfolio yield has an intermediate value between the yields
of both securities (but portfolio is risk-free!). One can check the results for
portfolio yield, calculating it by the formula (4.8) x1 1 x2 2
0:583 0:2 0:417 0:4 0:283.
10.1.3 Independent Securities
For independent securities,
12 0: 10:14
For the square of the portfolio risk (variance), we have
2 21 x21 22 x22 : 10:15
Let us find a minimum-risk portfolio and its profitability and risk. For this, it is
necessary to minimize the objective function
2 21 x21 22 x22 10:16
under condition
x1 x2 1: 10:17
This is the task of a conditional extremum which is solved using the Lagrange
function
L 21 x21 22 x22 x1 x2 1: 10:18
To find the stationary points, we have the system

8
>
> L
>
> 2 21 x1 0
>
> x
< 1
L
2 22 x2 0 ; 10:19
>
> x
>
> L
2
>
>
: x1 x2 1 0

Subtracting the first equation from the second, we obtain
21 x1 22 x2 : 10:20
Next, using the third equation, we have
21 x1 22 1 x1 : 10:21
Hence
22 21
x1 , x2 : 10:22
21 22 21 22
Portfolio

22 21
X ; ; 10:23
21 22 21 22
and its yield
1 22 2
22 12: 10:24
21 2 1 2
2
The portfolio risk is equal to

s
p 21 42 41 42
21 x21 22 x22 2 2
1 22
s
10:25
21 22 21 22 12
2 2 p :
1 2 2 2 2
1 2
Note that in the case of three securities, there is no direct analogy with (10.22) (see
10.1.4).
Example 10.2
Using formula (4.40), it is easy to demonstrate the effect of diversification on
portfolio risk. Suppose a portfolio consists of two independent securities with
risks 1 0:1 and 2 0:2, respectively. Let us calculate the portfolio risk by
using formula (10.24)
12 0:1 0:2
p p 0:0894:
21 22 0:01 0:04
Thus, the portfolio risk 0:0894 turns out to be lower than the risk of each of the
securities (0.1; 0.2). This is an illustration of the principle of diversification: with
smearing of the portfolio on an independent security, risk is reduced.
10.1.4 Three Independent Securities
Although this case goes beyond the issue of a portfolio of two securities, we
consider it here as a generalization of the case of a portfolio of two securities.
For independent securities,
12 13 23 0: 10:26
2 21 x21 22 x22 23 x23 : 10:27
We find a minimum-risk portfolio, its profitability, and risk. For this, it is necessary
to minimize the objective function
2 21 x21 22 x22 23 x23 ; 10:28
under condition
x1 x2 x3 1: 10:29
This is a task on conditional extremum, which is solved using the Lagrange

function.
Let us write the Lagrange function and find its extremum
L 21 x21 22 x22 23 x23 x1 x2 x3 1: 10:30
To find the stationary points, we have the system

8
>
> L
>
> x 2 1 x1 0
2
>
>
>
> L
1
>
>
< 2 22 x2 0
x2 10:31
>
> L
>
> 2 23 x3 0
>
> x
>
>
3
>
> L
: x1 x2 1 0:

Subtracting from the first equation the second one and then the third one, we obtain
21 x1 22 x2 ;
21 x1 22 x3 :
Hence
21 21
x2 x 1 , x 3 x1 : 10:32
22 23
Substituting (10.32) into the normalization condition
x1 x2 x3 1; 10:33
we get
21 21
x1 x 1 x1 1: 10:34
22 23
Hence
1 22 23
x1 : 10:35
2 2 22 23 21 23 21 22
1 12 12
2 3
Substituting this x1 value in (10.32), we get the rest two components of the portfolio
21 23
x2 ; 10:36
22 23 21 23 21 22
21 22
x3 : 10:37
22 23 21 23 21 22
The portfolio has the form
1 2 2 2 2 2 2
X 23; 1 3; 12 ; 10:38
22 23 21 23 21 22
and its yield is equal to
1 22 23 2 21 23 3 21 22
: 10:39
22 23 21 23 21 22
Portfolio risk is equal to

p
s 21 x21 22 x22 23 x23

12 3
1 2 3 22 41 43 23 41 42 p
2 4 4
: 10:40
2 2 2 2 2 22 22
23 1 3 12
2 2 2 2 2 3 1 3 1 2
Example 10.3
For a portfolio of three independent securities with yield and risk (0.1; 0.4),
(0.2; 0.6), and (0.4; 0.8) respectively, find the minimum-risk portfolio, its risk,
and yield. Portfolio of minimum risk is given by (10.38):
1
X 22 23 ; 21 23 ; 21 22
22 23 21 23 21 22

0:6 0:8 ; 0:4 0:8 ; 0:4 0:62
2 2 2 2 0:2304; 0:1024; 0:0576
2

0:6 0:8 0:4 0:8 0:4 0:6
2 2 2 2 2 2 0:2304 0:1024 0:0576
0:2304; 0:1024; 0:0576
0:590; 0:263; 0:147:
0:3904
So, X 0:590; 0:263; 0:147:

Risk of portfolio of minimum risk is found by formula (10.40)
10.2 Risk-free Security 165
123 0:4 0:6 0:8

p p
23 13 1 2
2 2 2 2 2 2
0:6 0:8 0:42 0:82 0:42 0:62
2 2
0:192 0:192 0:192
p p 0:307:
0:2304 0:1024 0:0576 0:3904 0:6348
Finally, yield of portfolio of minimum risk is found by formula (10.39):
1 22 23 2 21 23 3 21 22

22 23 21 23 21 22
0:1 0:62 0:82 0:2 0:42 0:82 0:4 0:42 0:62

0:62 0:82 0:42 0:82 0:42 0:62
0:02304 0:02048 0:02304 0:06656
0:1705:
0:2304 0:1024 0:0576 0:3904
It is seen that the portfolio risk is less than the risk of each individual security, and a
portfolio yield is more than the first security yield, a little less than the yield of the
second security, and less than the yield of third security.
10.2 Risk-free Security
Let one of the two portfolio securities to be risk-free. Portfolio of n-securities,

including risk-free one, is named after Tobin, who has investigated this case for the
first time. Considering portfolio has properties which are substantially different
from those of the portfolio consisting only of risky securities. Here we consider the
effect of the inclusion of a risk-free securities into the portfolio of two securities.
Thus, we have two securities: (1) (1, 0) and (2) (2, 2), with 1 < 2 (otherwise
it would be necessary to form a portfolio (1, 0) consisting only of the risk-free
securities, and we would have a risk-free portfolio of maximum yield).
We have the following equations:
1 x1 2 x2
2 x2 10:41
x1 x2 1:
From these equations, it is easy to get an admissible set of portfolios

1 1 x2 2 x2 1 2 1 x2 1 2 1 ;
2
which is a segment
Fig. 10.2 Admissible set of

portfolios, consisting of two
securities, one of which is
risk-free

yield and risk of the
portfolio on the share of the
risk-free security x1

1 2 1 , 0 2 : 10:42
2
At 0, portfolio is at a point 1 (1, 0), and at 2 , at a point 2 (2, 2)

(Fig. 10.2).
Although this case is very simple, it is nevertheless possible to draw two
conclusions:
1. The admissible set of portfolios does not depend on the correlation coefficient
(although usually risk-free securities are considered to be uncorrelated with the
other (risky) securities.
2. The admissible set of portfolios has been narrowed from a triangle to the
interval.
Note that a similar effect occurs in the case of Tobins portfolio.
In conclusion, we present the dependence of yield and risk of the portfolio on the
share of the risk-free securities (Fig. 10.3).
10.3 Portfolio of a Given Yield (Or Given Risk) 167
It is evident that the portfolio risk decreases linearly with x1: from 2 at x1 0 to
zero at x1 1, at the same time yield also decreases linearly with x1: from 2 at
x1 0 to 1 at x1 1.
10.3 Portfolio of a Given Yield (Or Given Risk)
In the case of a portfolio of two securities, given yield or its risk identifies portfolio
uniquely (except the case 1 2 , when only the given portfolio risk uniquely
identifies portfolio itself, see below for details).
Under the given yield (effectiveness) of the portfolio, it is uniquely defined as
the solution of the system

1 x1 2 x2
10:43
x1 x2 1;
and under the given portfolio risk, it is uniquely defined as the solution of the
system

2 21 x21 22 x22 212 1 2 x1 x2
10:44
x1 x2 1:
Therefore, in the case of a portfolio of two securities, it is not necessary to talk

about the minimal boundary (minimal risk portfolio for its given effectiveness).
Let us consider the first casethe given yield of the portfolio.
We will assume that 1 6 2 . The portfolio is uniquely defined as the solution of
the system (10.43)

1 x1 2 x2
x1 x2 1;
Expressing x2 from the second equation and substituting it in the first equation,
we get
x1 1 x2 2 x1 1 1 x1 2 x1 1 2 2 :
Hence, we find
2
x1 , x2 1 : 10:45
1 2 1 2
Substituting these expressions into the expression for the squared portfolio risk,
we obtain
21 2 2 22 1 2 2 1 2 12 1 2
2 : 10:46
2 1 2
Sometimes this equation mistakenly is called by the equation of the minimum

boundary. In fact, this equation describes the connection of portfolio risk to its
effectiveness.
Only at 1 2 , when the equality 1 2 is valid for all the values of x1
and x2 and the feasible set of portfolios is narrowing from the triangle to (vertical)
segment, we can speak of the minimal boundary, which in this case consists of a
single point (, 1) (at 1 < 2 ) or (, 2) (at 1 > 2 ).
Let us consider different limiting cases, considered by us above.
10.3.1 Case of Complete Correlation ( 12 1) and Complete

Anticorrelation (12 1)
As it is known, the correlation coefficient, , does not exceed unity on absolute

value, so let us study equation (10.46) for the extreme values 1.
First, we present general considerations.
For 1, it is known that random variables R1 and R2 are linearly dependent.
Without loss of generality, we can assume that R2 aR1 b. Then, a portfolio
yield can be written as follows:
RX x1 R1 1 x1 R2 x1 a1 x1 R1 1 x1 b: 10:47
Therefore,
2 x1 a1 x1 2 21 , x1 a1 x1 1 1 x1 b: 10:48
After elimination of the parameter x1, we obtain the following relation:
2 c d2 ; 10:49
i.e., risk, as a function of yield will take the form of a segment or angle (Fig. 10.1).
Now lets examine the equation (10.46) in cases 1.
Case of complete correlation (12 1)

1 2 2 1
10:50
2 1
Case of complete anticorrelation (12 1)

References 169

1 2 2 1

10:51
2 1
Independent securities (12 0)

Equation (10.46) takes the form
21 2 2 22 1 2
2 : 10:52
2 1 2
It could be shown that for intermediate values of the correlation coefficient ,

portfolio risk as a function of its efficiency has the form
2 2
2 : 10:53

If one finds the shape of the dependence of risk portfolio on its effectiveness for a
given portfolio {(1, 1), (2, 2)}, but for different values of the correlation coef-
ficient, , then we can come to the following conclusion: M decreases when the
correlation coefficient increases from 1 to 1.
In this case, a plot of the risk portfolio of its effectiveness is becoming more
elongated along the horizontal axis, i.e., for a fixed change in the expected yield ,
increase in the risk becomes smaller (Fig. 10.1).
If we also assume that x1 2 0, 1, and therefore x2 2 0, 1, it is implied from
the first formula (10.43) that 2 1 , 2 under the assumption 1 < 2 , as is their
convex combination. Portfolios are part of the boundary of AMB, namely, the part
that connects the points (1, 1) and (2, 2) (Fig. 10.1).
Thus, in the case n 2 and under the additional assumption that x1 0, x2 0,
the set of portfolios is a hyperbola or pieces of broken lines connecting the points
(1, 1) and (2, 2).
References
Brusov P, Filatova T (2014) Financial mathematics for masters. KNORUS, Moscow, 480
Brusov P, Brusov PP, Orehova N, Skorodulina S (2010) Financial mathematics for bachelor.
KNORUS, Moscow, 224
Brusov P, Brusov PP, Orehova N, Skorodulina S (2012) Tasks on financial mathematics for
bachelor. KNORUS, Moscow, 285
Chapter 11
Investment Models with Debt Repayment at
the End of the Project and Their Application
In this chapter, we build modern investment models, which will be used in the
following chapters for investigation of different problems of investments, such as
influence of debt financing, leverage level, taxing, project duration, method of
financing, and some other parameters on efficiency of investments and other
problems.
11.1 Investment Models
The effectiveness of the investment project is considered from two perspectives: the
owners of equity and debt and the equity holders only. For each of these cases, NPV
is calculated in two ways: with the division of credit and investment flows (and thus
discounting of the payments using two different rates) and without such a division
(in this case, both flows are discounted using the same rate, as which can be,
obviously, chosen WACC). For each of the four situations, two cases are consid-
ered: (1) a constant value of equity S and (2) a constant value of the total invested
capital I S + D (D is value of debt funds).
As it was stated above, the effectiveness of the investment project is considered
from two perspectives: the owners of equity and debt and the equity holders only. In
the first case, the interest and duty paid by owners of equity (negative flows)
returned to the project because they are exactly equal to the flow (positive),
obtained by owners of debt capital. The only effect of leverage in this case is
the effect of the tax shield, generated from the tax relief: interest on the loan is
entirely included into the cost and thus reduces the tax base. After-tax flow of
capital for each period in this case is equal to

DOI 10.1007/978-3-319-14732-1_11
172 11 Investment Models with Debt Repayment at the End of the Project and Their. . .
NOI1 t kd Dt 11:1
and the value of investments at the initial time moment T 0 is equal to I S

D.
Here NOI stands for net operating income (before taxes).
In the second case, investments at the initial time moment T 0 are equal to S
and the flow of capital for the period (in addition to the tax shields kdDt it includes a
payment of interest on a loan kd D):
NOI kd D1 t: 11:2
Here, for simplicity, we suppose that interest on the loan will be paid in equal shares
kdD during all periods. Note that principal repayment is made at the end of the last
period.
Some variety of repayment of long-term loans will be considered below (see in
Chap. 14).
We will consider two different ways of discounting:
1. Operating and financial flows are not separated and both are discounted, using
the general rate (as which, obviously, the weighted average cost of capital
(WACC) can be selected). In this case for perpetuity projects, the Modigliani
Miller formula (odigliani and iller 1958, 1963, 1966) for WACC will be
used and for projects of finite (arbitrary) duration BrusovFilatovaOrekhova
formula (Brusov and Filatova 2011; Brusov et al. 2011a, b, c, 2012a, b, 2013a, b,
2014a, b; Filatova et al. 2008; Brusova 2011).
2. Operating and financial flows are separated and are discounted at different rates:
the operating flow at the rate which is equal to the equity cost ke, depending on
leverage, and credit flowat the rate which is equal to the debt cost kd, which
until fairly large values of leverage remain constant and start to grow only at
high values of leverage L, when there is a danger of bankruptcy.
Note that loan capital is the least risky, because interest on credit is paid after
taxes in the first place. Therefore, the cost of credit will always be less than the
equity cost, whether of ordinary or of preference shares ke > kd ; k p > kd . Here
ke; kp is the equity cost of ordinary or of preference shares consequently.

the Perspective of the Equity Holders Only
11.2.1 With the Division of Credit and Investment Flows
Projects of Finite (Arbitrary) Duration

In this case, the expression for NPV has a view
11.2 The Effectiveness of the Investment Project from the Perspective of the. . . 173
X
n
NOI1 t X
n
kd D1 t D
NPV S i i 1 k n
i1 1 k
e i1 1 k
d d
NOI1 t 1 1 D
S 1 n D1 t 1 n :
ke 1 k e 1 k d 1 k d n
11:3
The last term in the first line-discounted (present) value of credit, extinguished a
one-off payment at the end of the last period n.
Below we will look at two cases:
1. A constant value of the invested capital I S + D (Ddebt value)
2. A constant value of equity capital S
We will start with the first case.
At a Constant Value of the Invested Capital (I const)
In the case of a constant value of the invested capital (I const), taking into account
D IL=1 L, S I=1 L, one gets

I 1 1
NPV 1 L 1 t 1
1L 1 k d n 1 k d n
11:4
NOI1 t 1
1 :
ke 1 k e n
For 1-Year Project

Putting at the Eq. (11.4) n 1, one gets for NPV

I 1 k d 1 t NOI1 t
NPV 1L : 11:5
1L 1 k d 1 ke
At a Constant Value of Equity Capital (S const)

Accounting that in the case S const NOI is proportional to the invested capital,
NOI I S1 L, we get

1 1
NPV S 1 L 1 t 1
1 k d n 1 k d n
11:6
S1 L1 t 1
1 :
ke 1 ke n
For 1-Year Project


1 kd 1 t S1 L1 t
NPV S 1 L : 11:7
1 kd 1 ke
11.3 Without Flows Separation
In this case operating and financial flows are not separated and are discounted, using
the general rate (as which, obviously, WACC can be selected).
The credit reimbursable at the end of the project (at the end of the period (n)) can
be discounted either at the same rate WACC or at the debt cost rate kd. Now we
choose a uniform rate and the first option.
X
n
NOI1 t kd D1 t D
NPV S
1 WACC i 1 WACCn
i1

NOI1 t kd D1 t 1 D
S 1 :
WACC 1 WACCn 1 WACCn
11:8

In case of a constant value of the invested capital (I const), taking into account

I kd 1 t 1 L
NPV 1L 1
1L WACC 1 WACCn 1 WACCn

NOI1 t 1
1 :
WACC 1 WACCn
11:9
For 1-Year Project

Putting into Eq. (11.9) n 1, one gets for NPV

I 1 kd 1 t NOI1 t
NPV 1L : 11:10
1L 1 WACC 1 WACC

Accounting that in the case S const NOI is proportional to the invested capital, I,
NOI I S1 L, and substituting D LS, we get
11.4 ModiglianiMiller Limit (Perpetuity Projects) 175

NOI1 t kd D1 t 1
NPV S 1
WACC 1 WACCn
D
; 11:11
1 WACCn

Lkd 1 t 1 L
NPV S 1 1
11:12
S1 L1 t 1
1 :
WACC 1 WACCn
For 1-Year Project

Putting into Eq. (11.12) n 1, one gets for NPV

Lkd 1 t 1 L
NPV S 1 1

S1 L1 t 1
1 :
WACC 1 WACCn
NOI1 t kd D1 t D
NPV S : 11:13
1 WACC
Substituting D LS, NOI I S1 L, we get

Lkd 1 t 1 S1 L1 t
NPV S 1 : 11:14
1 WACC 1 WACC
11.4 ModiglianiMiller Limit (Perpetuity Projects)
11.4.1 With Flows Separation
In perpetuity limit (ModiglianiMiller limit) (turning to the limit n ! 1 in the

relevant equations), we have
NOI1 t
NPV S D1 t: 11:15
ke

At a constant value of the invested capital (I const), accounting D IL=1 L,
S I=1 L, we get
I NOI1 t
NPV 1 L1 t : 11:16
1L ke
I NOI1 t
NPV 1 L1 t : 11:17
1L k0 k0 kd L1 t
In order to obtain Eqs. (11.17) from (11.16), we used the ModiglianiMiller

formula (odigliani and iller 1963) for equity cost ke for perpetuity projects:
ke k0 k0 kd L1 t: 11:18

Accounting D LS, we get in perpetuity limit (n ! 1) (ModiglianiMiller limit)
S1 L1 t
NPV S1 L1 t : 11:19
k0 k0 kd Lt
11.4.2 Without Flows Separation
In perpetuity limit (n ! 1) (ModiglianiMiller limit) (turning to the limit n ! 1

in the relevant equations), we have
NOI1 t kd D1 t
NPV S : 11:20
WACC

S I=1 L, we get
L
NOI1 t I k d 1 t
NPV I
1
1 L
1L WACC 11:21

1 Lkd 1 t NOI1 t
I 1 :
1L k0 1 Lt=1 L k0 1 Lt=1 L

NOI1 t kd D1 t
NPV S 11:22
WACC
Substituting D LS, we get


Lkd 1 t NOI1 t
NPV S 1
WACC WACC 11:23
Lkd 1 t S1 L1 t
S 1 :
k0 1 Lt=1 L k0 1 Lt=1 L

the Perspective of the Owners of Equity and Debt
Projects of Arbitrary (Finite) Duration

In this case, operating and financial flows are separated and are discounted, using
different rates: the operating flow at the rate equal to the equity cost ke, depending
on leverage, and credit flowat the rate equal to the debt cost kd, which until fairly
large values of leverage remain constant and start to grow only at high values of
leverage L, when there is a danger of bankruptcy.
X
n
NOI1 t X
n
kd Dt
NPV I i

1 k e i1 1 k d i
i1 11:24
NOI1 t 1 1
I 1 Dt 1 :
ke 1 k e n 1 kd n
Below we will consider two cases:

1. At a constant value of the invested capital (I S + D (D is the debt value)
2. At a constant value of equity capital S
We will start with the first case.
S I=1 L, we get

NOI1 t 1 ILt 1
NPV I 1 1
ke 1 ke n 1L 1 k d n

Lt 1 NOI1 t 1
I 1 1 1 :
1L 1 kd n ke 1 k e n
11:25

Accounting D LS, I S1 L, we get

NOI1 t 1 1
NPV S LS 1 Dt 1 : 11:26
ke 1 k e n 1 kd n
Accounting that in the case S const NOI is not a constant, but is proportional to
the invested capital, NOI I S1 L, we get

1
NPV S 1 L tL 1
1 kd n

S1 L1 t 1
1 : 11:27
ke 1 ke n
For 1-Year Project

kd S1 L1 t
NPV S 1 L tL : 11:28
1 kd 1 ke
In this case operating and financial flows are not separated and both are discounted,
using the general rate (as which, obviously, WACC can be selected):
X
n
NOI1 t kd Dt
NPV I
1 WACCi
i1 11:29
NOI1 t kd Dt 1
I 1 :
WACC 1 WACCn

At a constant value of the invested capital (I const), we have

NOI1 t kd Dt 1
NPV I 1 :
WACC 1 WACCn
Accounting D IL=1 L, S I=1 L, we get

2 0 13
L
6 kd t 7
NPV I 6 1 L B1 1
n C
41 @ A75
L 1 k0 1 1L
L
t
k0 1 t
10L 1 11:30
NOI1 t B
n C
1
@1 A:
L 1 k0 1 1Lt
L
k0 1 t
1L
11.6 ModiglianiMiller Limit 179
For 1-Year Project

" #
L
kd t1L NOI1 t
NPV I 1 : 11:31
1 WACC 1 WACC

NOI1 t kd Dt 1
NPV I 1
WACC 1 WACCn

kd Lt 1
S 1 L 1 11:32
WACC 1 WACCn

S1 L1 t 1
1 :
WACC 1 WACCn
For 1-Year Project

NOI1 t kd Dt
NPV I
1 WACC
11:33
kd Lt NOI1 t
S 1 L :
1 WACC 1 WACC
11.6 ModiglianiMiller Limit
In perpetuity limit (n ! 1) (ModiglianiMiller limit), we have
NOI1 t
NPV I Dt: 11:34
ke

we have

L NOI1 t
NPV I 1 t : 11:35
1L ke
For equity cost ke and WACC in ModiglianiMiller theory, we have consequently
ke k0 k0 kd L1 t; 11:36
WACC k0 1 wd t k0 1 Lt=1 L: 11:37
Putting Eqs. (11.36) into (11.37), we get


L NOI1 t
NPV I 1 t : 11:38
1L k0 k0 kd L1 t

Accounting D LS, I S1 L, in perpetuity limit
(n ! 1) (ModiglianiMiller limit), we have
NOI1 t
NPV S1 L1 t : 11:39
k0 k0 kd Lt
Note that in the case S const NOI is not a constant, but is proportional to the
invested capital, NOI I S1 L.
In this case, Eq. (11.38) is replaced by
S1 L1 t
NPV S1 L1 t ; 11:40
k0 k0 kd Lt
NOI1 t kd Dt
NPV I : 11:41
WACC
At a constant value of the invested capital (I const), we have
NOI1 t kd Dt
NPV I
WACC
0 1
L
kd t1L NOI1 t
I @1 A : 11:42
k0 1 1LtL
k0 1 1L
L
t


kd Lt NOI1 t
NPV S 1 L : 11:43
WACC WACC
2 3
k Lt S1 L1 t
NPV S41 L 5 :
d
11:44
k0 1 1LtL
k0 1 1L
L
t
References 181
References
(11):815824
capital structure, different from suggested by trade off theory. Cogent Econ Finance 2:113,
http://dx.doi.org/10.1080/23322039.2014.946150
Econ Rev 53:147175
19541957. Am Econ Rev 56:333391
Chapter 12
Influence of Debt Financing on the Efficiency
of Investment Projects: The Analysis
of Efficiency of Investment Projects Within
the Perpetuity (ModiglianiMiller)
Approximation
In this chapter, we conduct the analysis of effectiveness of investment projects

within the perpetuity (ModiglianiMiller) approximation (odigliani and iller
1958, 1963, 1966). Based on the obtained in previous chapter results for NPV
Filatova et al. 2008; Brusova 2011), we analyze the effectiveness of investment
projects for three cases:
1. At a constant difference between equity cost (at L 0) and debt cost
k k0 kd
2. At a constant equity cost (at L 0) and varying debt cost kd
3. At a constant debt cost kd and varying equity cost (at L 0) k0
The dependence of NPV on investment value and/or equity value will be also
analyzed. The results are shown in the form of tables and graphs.
It should be noted that the obtained tables have played an important practical
role in determining the optimal or acceptable debt level, at which the project
remains effective. The optimal debt level there is for the situation, when in the
dependence of NPV on leverage level L there is an optimum (leverage level value,
at which NPV reaches a maximum value). An acceptable debt level there is for the
situation, when NPV decreases monotonically with leverage. And, finally, it is
possible that NPV is growing with leverage. In this case, an increase in borrowing
leads to increased effectiveness of investment projects, and their limit is determined
by financial sustainability of investing company.

DOI 10.1007/978-3-319-14732-1_12
184 12 Influence of Debt Financing on the Efficiency of Investment Projects: The. . .

At a Constant Value of the Total Invested Capital (I Const)

I NOI1 t
NPV 1 L1 t 12:1
1L k0 k0 kd L1 t
1. At the constant values of k k0 kd , NPV practically always decreases with

leverage. At small L for many pairs of values k0 and kd (e.g., k0 (14 %) and kd
(12 %), k0 (18 %) and kd (16 %), and many others), there is an optimum in the
dependence of NPV(L ) at small L 2:
For higher values of k0 (and, accordingly, kd), curves NPV(L ) lie below. With
increase of NOI, all curves NPV(L ) are shifted in parallel upward.
2. At the constant values of k0, NPV practically always decreases with leverage,
passing through (most often), or not passing (more rarely) through, optimum in
the dependence of NPV(L ) at small L 2:
All curves NPV(L ) at the constant values of k0 are started (at L 0) from a
single point, and with the increasing of kd (and, respectively, a decrease of k),
curves NPV(L ) lie above. With increase of NOI, all curves NPV(L) are shifted in
parallel upward practically.
3. At the constant values of kd, NPV practically always decreases with leverage,
optimum in the dependence of NPV(L) is absent.
All curves NPV(L ) at the constant values of k0 are started (at L 0) from a
single point. With the increasing of k0 (and, respectively, an increase of k),
curves NPV(L) are shifted into region of higher NPV values. With increase of
NOI, all curves NPV(L ) are shifted in parallel upward practically (Table 12.1;
Figs. 12.1 and 12.2).
12.1
Table 12.1 NOI 1,200, I 2,000, k0kd const

L
k0 kd 0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0 4.5
1 0.08 0.06 10,000.0 9,042.4 8,200.0 7,470.8 6,838.1 6,285.7 5,800.0 5,369.9 4,986.7 4,643.1
2 0.10 0.08 7,600.0 7,022.2 6,475.9 5,981.9 5,539.4 5,142.9 4,786.5 4,465.0 4,173.7 3,908.7
3 0.14 0.12 4,857.1 4,619.8 4,353.8 4,093.7 3,848.1 3,619.0 3,406.4 3,209.1 3,025.9 2,855.6
4 0.18 0.16 3,333.3 3,239.7 3,098.0 2,945.9 2,795.0 2,649.4 2,510.5 2,378.9 2,254.4 2,136.8
5 0.24 0.22 2,000.0 2,004.3 1,950.0 1,876.4 1,796.1 1,714.3 1,633.3 1,554.4 1,477.9 1,404.2
6 0.30 0.28 1,200.0 1,250.2 1,238.0 1,203.0 1,158.2 1,109.2 1,058.6 1,007.7 957.4 907.9
7 0.36 0.34 666.7 742.0 753.2 740.0 715.6 685.7 652.9 618.8 584.2 549.5
8 0.40 0.38 400.0 486.3 507.7 504.2 488.9 467.5 442.9 416.4 389.0 361.2
9 0.44 0.42 181.8 276.2 305.3 309.0 300.6 285.7 267.2 246.6 224.8 202.3
10 0.10 0.06 7,600.0 6,409.2 5,472.7 4,726.5 4,120.3 3,619.0 3,198.0 2,839.4 2,530.5 2,261.7
11 0.12 0.08 6,000.0 5,192.2 4,515.8 3,954.3 3,484.1 3,085.7 2,744.4 2,449.0 2,191.0 1,963.6
12 0.16 0.12 4,000.0 3,587.9 3,200.0 2,855.4 2,552.4 2,285.7 2,050.0 1,840.5 1,653.3 1,485.2
13 0.20 0.16 2,800.0 2,577.8 2,337.9 2,111.0 1,903.0 1,714.3 1,543.2 1,388.0 1,246.8 1,118.0
14 0.24 0.20 2,000.0 1,883.3 1,729.4 1,573.3 1,424.6 1,285.7 1,157.1 1,038.4 928.7 827.3
15 0.30 0.26 1,200.0 1,171.3 1,091.6 998.6 904.0 812.0 724.2 641.2 563.0 489.4
16 0.36 0.32 666.7 686.5 649.0 592.9 530.8 467.5 405.3 345.0 287.2 232.0
17 0.40 0.36 400.0 441.0 422.2 382.9 335.6 285.7 235.5 186.1 138.2 92.0
The Effectiveness of the Investment Project from the Perspective of the. . .
18 0.44 0.40 181.8 238.6 233.9 207.2 171.4 131.9 91.0 50.2 10.1 28.9
(continued)
185
186
L
k0 kd 5.0 5.5 6.0 6.5 7.0 7.5 8.0 8.5 9.0 9.5 10.0
1 0.08 0.06 4,333.3 4,052.7 3,797.4 3,564.1 3,350.0 3,152.9 2,970.9 2,802.3 2,645.7 2,499.8 2,363.6
12
2 0.10 0.08 3,666.7 3,444.8 3,240.8 3,052.5 2,878.3 2,716.6 2,566.1 2,425.7 2,294.4 2,171.4 2,055.9
3 0.14 0.12 2,697.0 2,549.0 2,410.7 2,281.1 2,159.5 2,045.2 1,937.6 1,836.2 1,740.3 1,649.6 1,563.6
4 0.18 0.16 2,025.6 1,920.6 1,821.1 1,726.9 1,637.7 1,552.9 1,472.4 1,395.9 1,323.0 1,253.5 1,187.2
5 0.24 0.22 1,333.3 1,265.3 1,200.0 1,137.4 1,077.3 1,019.6 964.3 911.1 860.0 810.9 763.6
6 0.30 0.28 859.6 812.7 767.1 722.9 680.1 638.7 598.5 559.7 522.2 485.8 450.6
7 0.36 0.34 515.2 481.3 448.1 415.6 383.9 352.9 322.8 293.4 264.8 236.9 209.8
8 0.40 0.38 333.3 305.7 278.3 251.4 225.0 199.1 173.7 148.9 124.7 101.0 77.9
9 0.44 0.42 179.5 156.6 133.9 111.4 89.1 67.2 45.7 24.6 3.8 16.5 36.4
10 0.10 0.06 2,025.6 1,816.7 1,630.5 1,463.5 1,313.0 1,176.5 1,052.2 938.5 834.2 738.1 649.4
11 0.12 0.08 1,761.9 1,581.7 1,419.8 1,273.5 1,140.7 1,019.6 908.7 806.9 712.9 626.1 545.5
12 0.16 0.12 1,333.3 1,195.6 1,070.1 955.4 850.0 752.9 663.2 580.1 502.9 430.9 363.6
13 0.20 0.16 1,000.0 891.7 791.8 699.6 614.2 534.8 460.8 391.8 327.2 266.7 209.8
14 0.24 0.20 733.3 646.2 565.1 489.5 419.0 352.9 291.0 232.9 178.2 126.6 77.9
15 0.30 0.26 420.3 355.3 294.1 236.4 182.1 130.7 82.2 36.2 7.3 48.7 88.0
16 0.36 0.32 179.5 129.5 82.0 36.8 6.2 47.1 86.0 123.1 158.5 192.3 224.6
17 0.40 0.36 47.6 5.1 35.5 74.4 111.5 147.1 181.0 213.5 244.7 274.5 303.0
18 0.44 0.40 66.7 103.1 138.2 171.9 204.2 235.3 265.1 293.8 321.3 347.8 373.2
Influence of Debt Financing on the Efficiency of Investment Projects: The. . .
Fig. 12.1 Dependence of NPV(L), NOI=1200, t = 20% NPV

NPV on leverage level at 12000
fixed values of k0 and kd
1 10000
8000
2
6000
3
4000
4
5 2000
6
7
8
9 0
0 1 2 3 4 5 6 7 8 9 10 11
-2000
L

fixed values of k0 and kd 10
7000
11 6000
5000
12 4000
3000
13
14 2000
15 1000
16
17
18 0
0 1 2 3 4 5 6 7 8 9 10 11
-1000
L
At a Constant Equity Value (S Const)

S1 L1 t
NPV S1 L1 t 12:2
k0 k0 kd Lt

leverage. The optimum in the dependence of NPV(L ) has been found for one
pair of k0 and kd [k0 (8 %) and kd (6 %)] only.
All curves NPV(L ) at the constant values of k0 are started (at L 0) from one
point, and with growth of k0 (and, accordingly, kd), all curves NPV(L ) lie below.
With growth of k, density of curves NPV(L ) increases.
2. At the constant values of k0, NPV practically always decreases with leverage.
Optimum in the dependence of NPV(L ) is absent.
point, and with growth of kd (and, respectively, a decrease of k), all curves
NPV(L ) are shifted upward. With growth of k, density of curves NPV(L )
increases.
3. At the constant values of kd, NPV practically always decreases with leverage.
The optimum in the dependence of NPV(L ) has been found for one pair of k0 and
kd [k0 (8 %) and kd (6 %)] only.
point, and with growth of k0 (and, respectively, an increase of k), curves NPV
(L ) are shifted into region of smaller NPV values. With growth of k, density of
curves NPV(L) increases (Table 12.2; Figs. 12.3 and 12.4).
12.1
Table 12.2 S 1,000, 0.1, k0kd const

L
k0 kd 0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0 4.5
1 0.08 0.06 0.0 63.4 104.8 125.6 127.3 111.1 78.3 29.8 33.3 110.2
2 0.10 0.08 200.0 223.5 261.5 313.2 377.8 454.5 542.9 642.1 751.7 871.2
3 0.14 0.12 428.6 554.9 688.9 830.1 978.4 1,133.3 1,294.7 1,462.3 1,635.9 1,815.2
4 0.18 0.16 555.6 740.7 930.4 1,124.7 1,323.4 1,526.3 1,733.3 1,944.3 2,159.2 2,377.8
5 0.24 0.22 666.7 904.1 1,144.3 1,387.0 1,632.3 1,880.0 2,130.2 2,382.7 2,637.5 2,894.6
6 0.30 0.28 733.3 1,002.6 1,273.7 1,546.4 1,820.8 2,096.8 2,374.4 2,653.5 2,934.2 3,216.4
7 0.36 0.34 777.8 1,068.5 1,360.4 1,653.6 1,947.8 2,243.2 2,539.8 2,837.4 3,136.2 3,436.0
8 0.40 0.38 800.0 1,101.5 1,404.0 1,707.4 2,011.8 2,317.1 2,623.3 2,930.4 3,238.5 3,547.4
9 0.44 0.42 818.2 1,128.5 1,439.6 1,751.6 2,064.3 2,377.8 2,692.0 3,007.0 3,322.8 3,639.3
10 0.10 0.06 200.0 246.2 318.5 414.3 531.0 666.7 819.4 987.5 1,169.7 1,364.7
11 0.12 0.08 333.3 432.3 550.0 684.8 835.3 1,000.0 1,177.8 1,367.6 1,568.4 1,779.5
12 0.16 0.12 500.0 668.3 847.6 1,037.2 1,236.4 1,444.4 1,660.9 1,885.1 2,116.7 2,355.1
13 0.20 0.16 600.0 811.8 1,030.8 1,256.6 1,488.9 1,727.3 1,971.4 2,221.1 2,475.9 2,735.6
14 0.24 0.20 666.7 908.2 1,154.8 1,406.3 1,662.5 1,923.1 2,187.9 2,456.7 2,729.4 3,005.8
15 0.30 0.26 733.3 1,005.3 1,280.5 1,559.0 1,840.5 2,125.0 2,412.3 2,702.4 2,995.2 3,290.5
16 0.36 0.32 777.8 1,070.3 1,365.2 1,662.4 1,961.7 2,263.2 2,566.7 2,872.2 3,179.6 3,488.9
17 0.40 0.36 800.0 1,103.0 1,407.8 1,714.6 2,023.1 2,333.3 2,645.3 2,958.9 3,274.1 3,590.8
18 0.44 0.40 818.2 1,129.7 1,442.9 1,757.5 2,073.7 2,391.3 2,710.3 3,030.8 3,352.5 3,675.6
(continued)
189
190
L
k0 kd 5.0 5.5 6.0 6.5 7.0 7.5 8.0 8.5 9.0 9.5 10.0
1 0.08 0.06 200.0 302.0 415.4 539.6 674.1 818.2 971.4 1,133.3 1,303.4 1,481.4 1,666.7
12
2 0.10 0.08 1,000.0 1,137.7 1,283.9 1,438.1 1,600.0 1,769.2 1,945.5 2,128.4 2,317.6 2,513.0 2,714.3
3 0.14 0.12 2,000.0 2,190.1 2,385.4 2,585.5 2,790.5 3,000.0 3,214.0 3,432.2 3,654.5 3,880.9 4,111.1
4 0.18 0.16 2,600.0 2,825.7 3,054.9 3,287.4 3,523.1 3,761.9 4,003.8 4,248.6 4,496.3 4,746.8 5,000.0
5 0.24 0.22 3,153.8 3,415.3 3,678.8 3,944.4 4,211.9 4,481.5 4,752.9 5,026.3 5,301.4 5,578.4 5,857.1
6 0.30 0.28 3,500.0 3,785.1 4,071.6 4,359.5 4,648.8 4,939.4 5,231.3 5,524.6 5,819.0 6,114.8 6,411.8
7 0.36 0.34 3,736.8 4,038.7 4,341.7 4,645.6 4,950.5 5,256.4 5,563.3 5,871.1 6,179.8 6,489.4 6,800.0
8 0.40 0.38 3,857.1 4,167.8 4,479.2 4,791.5 5,104.7 5,418.6 5,733.3 6,048.8 6,365.1 6,682.2 7,000.0
9 0.44 0.42 3,956.5 4,274.5 4,593.1 4,912.4 5,232.5 5,553.2 5,874.6 6,196.6 6,519.3 6,842.7 7,166.7
10 0.10 0.06 1,571.4 1,788.9 2,016.2 2,252.6 2,497.4 2,750.0 3,009.8 3,276.2 3,548.8 3,827.3 4,111.1
11 0.12 0.08 2,000.0 2,229.3 2,466.7 2,711.6 2,963.6 3,222.2 3,487.0 3,757.4 4,033.3 4,314.3 4,600.0
12 0.16 0.12 2,600.0 2,851.0 3,107.7 3,369.8 3,637.0 3,909.1 4,185.7 4,466.7 4,751.7 5,040.7 5,333.3
13 0.20 0.16 3,000.0 3,268.9 3,541.9 3,819.0 4,100.0 4,384.6 4,672.7 4,964.2 5,258.8 5,556.5 5,857.1
14 0.24 0.20 3,285.7 3,569.0 3,855.6 4,145.2 4,437.8 4,733.3 5,031.6 5,332.5 5,635.9 5,941.8 6,250.0
15 0.30 0.26 3,588.2 3,888.4 4,190.8 4,495.5 4,802.2 5,111.1 5,422.0 5,734.8 6,049.5 6,366.0 6,684.2
16 0.36 0.32 3,800.0 4,112.9 4,427.5 4,743.7 5,061.5 5,381.0 5,701.9 6,024.3 6,348.1 6,673.4 7,000.0
17 0.40 0.36 3,909.1 4,228.8 4,550.0 4,872.6 5,196.5 5,521.7 5,848.3 6,176.1 6,505.1 6,835.3 7,166.7
18 0.44 0.40 4,000.0 4,325.6 4,652.5 4,980.5 5,309.7 5,640.0 5,971.4 6,303.9 6,637.5 6,972.1 7,307.7
Fig. 12.3 Dependence of NPV(L), t = 20% NPV

0
0 1 2 3 4 5 6 7 8 9 10 11
-1000
1
-2000
2
-3000
3 -4000
4 -5000
5 -6000
6
7
8 -7000
9
-8000
L
Fig. 12.4 Dependence of NPV(L), t = 20%

NPV on leverage level at NPV
0 1 2 3 4 5 6 7 8 9 10 11
-1000
-2000
-3000
10 -4000
11
-5000
12
13 -6000
14
15
16 -7000
17
18
-8000
L
At a Constant Investment Value (I Const)

1 Lkd 1 t NOI1 t
NPV I 1 12:3
1L k0 1 Lt=1 L k0 1 Lt=1 L
1. At the constant values of k k0 kd , NPV demonstrates a limited growth with

leverage with output into saturation regime. The main increase in NPV occurs
when L 3 6. With growth of k0 (and kd), the urves NPV(L ) are lowered.
With growth of NOI, all curves NPV(L ) are shifted practically parallel
upward.
2. At the constant values of k0, NPV demonstrates a limited growth with leverage
with output into saturation regime. All curves NPV(L ) at the constant values of
k0 and different values of kd are started (at L 0) from one point; the higher
values of kd correspond to more low-lying curves NPV(L ). Optimum in depen-
dence of NPV(L) is absent. With growth of NOI, all curves NPV(L) are shifted
practically parallel upward.
3. At the constant values of kd, NPV grows with leverage with output into satura-
tion regime. All curves NPV(L) at the constant values of k0 and different values
of kd are started (at L 0) from one point; the higher values of k0 (and higher
values of k k0 kd ) correspond to more low-lying curves NPV(L ). Opti-
mum in dependence of NPV(L ) is absent (Table 12.3, Figs. 12.5 and 12.6).
12.1

L
k0 kd 0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0 4.5
1 0.08 0.06 10,000.0 11,095.2 11,666.7 12,018.2 12,256.4 12,428.6 12,558.8 12,660.8 12,742.9 12,810.3
2 0.10 0.08 7,600.0 8,495.2 8,955.6 9,236.4 9,425.6 9,561.9 9,664.7 9,745.0 9,809.5 9,862.5
3 0.14 0.12 4,857.1 5,523.8 5,857.1 6,057.1 6,190.5 6,285.7 6,357.1 6,412.7 6,457.1 6,493.5
4 0.18 0.16 3,333.3 3,873.0 4,135.8 4,290.9 4,393.2 4,465.6 4,519.6 4,561.4 4,594.7 4,621.9
5 0.24 0.22 2,000.0 2,428.6 2,629.6 2,745.5 2,820.5 2,873.0 2,911.8 2,941.5 2,965.1 2,984.2
6 0.30 0.28 1,200.0 1,561.9 1,725.9 1,818.2 1,876.9 1,917.5 1,947.1 1,969.6 1,987.3 2,001.6
7 0.36 0.34 666.7 984.1 1,123.5 1,200.0 1,247.9 1,280.4 1,303.9 1,321.6 1,335.4 1,346.5
8 0.40 0.38 400.0 695.2 822.2 890.9 933.3 961.9 982.4 997.7 1,009.5 1,019.0
9 0.44 0.42 181.8 458.9 575.8 638.0 676.0 701.3 719.3 732.6 742.9 751.0
10 0.10 0.06 7,600.0 8,609.5 9,133.3 9,454.5 9,671.8 9,828.6 9,947.1 10,039.8 10,114.3 10,175.5
11 0.12 0.08 6,000.0 6,857.1 7,296.3 7,563.6 7,743.6 7,873.0 7,970.6 8,046.8 8,107.9 8,158.1
12 0.16 0.12 4,000.0 4,666.7 5,000.0 5,200.0 5,333.3 5,428.6 5,500.0 5,555.6 5,600.0 5,636.4
13 0.20 0.16 2,800.0 3,352.4 3,622.2 3,781.8 3,887.2 3,961.9 4,017.6 4,060.8 4,095.2 4,123.3
14 0.24 0.20 2,000.0 2,476.2 2,703.7 2,836.4 2,923.1 2,984.1 3,029.4 3,064.3 3,092.1 3,114.6
15 0.30 0.26 1,200.0 1,600.0 1,785.2 1,890.9 1,959.0 2,006.3 2,041.2 2,067.8 2,088.9 2,105.9
16 0.36 0.32 666.7 1,015.9 1,172.8 1,260.6 1,316.2 1,354.5 1,382.4 1,403.5 1,420.1 1,433.5
17 0.40 0.36 400.0 723.8 866.7 945.5 994.9 1,028.6 1,052.9 1,071.3 1,085.7 1,097.2
18 0.44 0.40 181.8 484.8 616.2 687.6 731.9 761.9 783.4 799.6 812.1 822.1
(continued)
193
194
L
k0 kd 5.0 5.5 6.0 6.5 7.0 7.5 8.0 8.5 9.0 9.5 10.0
1 0.08 0.06 12,866.7 12,914.5 12,955.7 12,991.4 13,022.7 13,050.4 13,075.1 13,097.2 13,117.1 13,135.1 13,151.5
12
2 0.10 0.08 9,906.7 9,944.2 9,976.4 10,004.3 10,028.8 10,050.4 10,069.7 10,086.9 10,102.4 10,116.5 10,129.3
3 0.14 0.12 6,523.8 6,549.5 6,571.4 6,590.5 6,607.1 6,621.8 6,634.9 6,646.6 6,657.1 6,666.7 6,675.3
4 0.18 0.16 4,644.4 4,663.5 4,679.8 4,693.9 4,706.2 4,717.1 4,726.7 4,735.3 4,743.1 4,750.1 4,756.5
5 0.24 0.22 3,000.0 3,013.3 3,024.6 3,034.4 3,042.9 3,050.4 3,057.1 3,063.0 3,068.3 3,073.1 3,077.4
6 0.30 0.28 2,013.3 2,023.2 2,031.5 2,038.7 2,044.9 2,050.4 2,055.3 2,059.6 2,063.4 2,066.9 2,070.0
7 0.36 0.34 1,355.6 1,363.1 1,369.5 1,374.9 1,379.6 1,383.8 1,387.4 1,390.6 1,393.5 1,396.1 1,398.4
8 0.40 0.38 1,026.7 1,033.0 1,038.4 1,043.0 1,047.0 1,050.4 1,053.5 1,056.1 1,058.5 1,060.7 1,062.6
9 0.44 0.42 757.6 763.0 767.6 771.5 774.8 777.7 780.2 782.5 784.5 786.3 787.9
10 0.10 0.06 10,226.7 10,270.1 10,307.4 10,339.8 10,368.2 10,393.3 10,415.6 10,435.6 10,453.7 10,470.0 10,484.8
11 0.12 0.08 8,200.0 8,235.5 8,266.0 8,292.5 8,315.7 8,336.1 8,354.4 8,370.7 8,385.4 8,398.7 8,410.8
12 0.16 0.12 5,666.7 5,692.3 5,714.3 5,733.3 5,750.0 5,764.7 5,777.8 5,789.5 5,800.0 5,809.5 5,818.2
13 0.20 0.16 4,146.7 4,166.4 4,183.3 4,197.8 4,210.6 4,221.8 4,231.8 4,240.8 4,248.8 4,256.0 4,262.6
14 0.24 0.20 3,133.3 3,149.1 3,162.6 3,174.2 3,184.3 3,193.3 3,201.2 3,208.3 3,214.6 3,220.4 3,225.6
15 0.30 0.26 2,120.0 2,131.8 2,141.9 2,150.5 2,158.1 2,164.7 2,170.6 2,175.8 2,180.5 2,184.7 2,188.6
16 0.36 0.32 1,444.4 1,453.6 1,461.4 1,468.1 1,473.9 1,479.0 1,483.5 1,487.5 1,491.1 1,494.3 1,497.2
17 0.40 0.36 1,106.7 1,114.5 1,121.2 1,126.9 1,131.8 1,136.1 1,139.9 1,143.3 1,146.3 1,149.1 1,151.5
18 0.44 0.40 830.3 837.1 842.8 847.7 851.9 855.6 858.9 861.7 864.3 866.6 868.7

12000
2 10000
8000
3
6000
4
4000
5
6 2000
7
8
9
0
0 1 2 3 4 5 6 7 8 9 10 11
L

10
10000
11
8000
12 6000
13 4000
14
15 2000
16
17
18
0
0 1 2 3 4 5 6 7 8 9 10 11
L

Lkd 1 t S1 L1 t
NPV S 1 12:4
k0 1 Lt=1 L k0 1 Lt=1 L
1. At the constant values of k k0 kd , NPV shows as an unlimited growth with

leverage and unlimited descending with leverage. It is interesting to note that the
credit rate value kd 10 % turns out to be a border at all surveyed values of
k k0 kd , equal to 2, 4, 6, and 10 % (it separates the growth of NPV with
leverage from descending of NPV with leverage). In other words, with growth of
kd, the transition from the growth of NPV with leverage to its descending with
leverage takes place, and at the credit rate kd 10 %, NPV does not depend on
the leverage at all surveyed values of k0.
Thus, we come to conclusion that for perpetuity projects, NPV grows with
leverage at a credit rate kd < 10 %, and NPV decreases with leverage at a credit
rate kd > 10 % (the project remains effective up to leverage levels L L0 , NP
VL0 0). Optimum in the dependence of NPV(L ) is absent.
2. At the constant values of kd, NPV shows an unlimited growth with leverage as
well as unlimited descending with leverage. NPV grows with leverage at a credit
rate kd < 10 %, and NPV decreases with leverage at a credit rate kd > 10 % (the
project remains effective up to leverage levels L L0 , NPVL0 0). All curves
NPV(L ) at the constant values of k0 and different values of kd are started
(at L 0) from one point; the higher values of k0 (and higher values of k k0
kd) correspond to more low-lying curves NPV(L ). Optimum in dependence of
NPV(L ) is absent.
3. At the constant values of k0, NPV as well as in the case of constant values of
k k0 kd shows an unlimited growth with leverage as well as unlimited
descending with leverage. An analysis of the data leads to the same conclusion
as that in (1): NPV grows with leverage at a credit rate kd < 10 % and NPV
decreases with leverage at a credit rate kd > 10 % (the project remains effective
up to leverage levels L L0 , NPVL0 0).
It should be noted that this pattern should be taken into account by the
regulator which should regulate the normative base in such a way that credit
rates of banks that depend on basic rate of Central Bank should not exceed, say,
10 %.
All curves NPV(L ) at the constant values of k0 and different values of kd are
started (at L 0) from one point; the higher values of kd (and lower values of
k k0 kd ) correspond to more low-lying curves NPV(L ). Optimum in
dependence of NPV(L ) is absent (Table 12.4, Figs. 12.7 and 12.8).
12.1

L
k0 kd 0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0 4.5
1 0.08 0.06 0.0 285.7 555.6 818.2 1,076.9 1,333.3 1,588.2 1,842.1 2,095.2 2,347.8
2 0.10 0.08 200.0 57.1 66.7 181.8 292.3 400.0 505.9 610.5 714.3 817.4
3 0.14 0.12 428.6 449.0 492.1 545.5 604.4 666.7 731.1 797.0 863.9 931.7
4 0.18 0.16 555.6 666.7 802.5 949.5 1,102.6 1,259.3 1,418.3 1,578.9 1,740.7 1,903.4
5 0.24 0.22 666.7 857.1 1,074.1 1,303.0 1,538.5 1,777.8 2,019.6 2,263.2 2,507.9 2,753.6
6 0.30 0.28 733.3 971.4 1,237.0 1,515.2 1,800.0 2,088.9 2,380.4 2,673.7 2,968.3 3,263.8
7 0.36 0.34 777.8 1,047.6 1,345.7 1,656.6 1,974.4 2,296.3 2,620.9 2,947.4 3,275.1 3,603.9
8 0.40 0.38 800.0 1,085.7 1,400.0 1,727.3 2,061.5 2,400.0 2,741.2 3,084.2 3,428.6 3,773.9
9 0.44 0.42 818.2 1,116.9 1,444.4 1,785.1 2,132.9 2,484.8 2,839.6 3,196.2 3,554.1 3,913.0
10 0.10 0.06 200.0 28.6 244.4 454.5 661.5 866.7 1,070.6 1,273.7 1,476.2 1,678.3
11 0.12 0.08 333.3 214.3 111.1 15.2 76.9 166.7 254.9 342.1 428.6 514.5
12 0.16 0.12 500.0 517.9 555.6 602.3 653.8 708.3 764.7 822.4 881.0 940.2
13 0.20 0.16 600.0 700.0 822.2 954.5 1,092.3 1,233.3 1,376.5 1,521.1 1,666.7 1,813.0
14 0.24 0.20 666.7 821.4 1,000.0 1,189.4 1,384.6 1,583.3 1,784.3 1,986.8 2,190.5 2,394.9
15 0.30 0.26 733.3 942.9 1,177.8 1,424.2 1,676.9 1,933.3 2,192.2 2,452.6 2,714.3 2,976.8
16 0.36 0.32 777.8 1,023.8 1,296.3 1,580.8 1,871.8 2,166.7 2,464.1 2,763.2 3,063.5 3,364.7
17 0.40 0.36 800.0 1,064.3 1,355.6 1,659.1 1,969.2 2,283.3 2,600.0 2,918.4 3,238.1 3,558.7
18 0.44 0.40 818.2 1,097.4 1,404.0 1,723.1 2,049.0 2,378.8 2,711.2 3,045.5 3,381.0 3,717.4
(continued)
197
198

L
k0 kd 5.0 5.5 6.0 6.5 7.0 7.5 8.0 8.5 9.0 9.5 10.0
1 0.08 0.06 2,600.0 2,851.9 3,103.4 3,354.8 3,606.1 3,857.1 4,108.1 4,359.0 4,609.8 4,860.5 5,111.1
12
2 0.10 0.08 920.0 1,022.2 1,124.1 1,225.8 1,327.3 1,428.6 1,529.7 1,630.8 1,731.7 1,832.6 1,933.3
3 0.14 0.12 1,000.0 1,068.8 1,137.9 1,207.4 1,277.1 1,346.9 1,417.0 1,487.2 1,557.5 1,627.9 1,698.4
4 0.18 0.16 2,066.7 2,230.5 2,394.6 2,559.1 2,723.9 2,888.9 3,054.1 3,219.4 3,384.8 3,550.4 3,716.0
5 0.24 0.22 3,000.0 3,246.9 3,494.3 3,741.9 3,989.9 4,238.1 4,486.5 4,735.0 4,983.7 5,232.6 5,481.5
6 0.30 0.28 3,560.0 3,856.8 4,154.0 4,451.6 4,749.5 5,047.6 5,345.9 5,644.4 5,943.1 6,241.9 6,540.7
7 0.36 0.34 3,933.3 4,263.4 4,593.9 4,924.7 5,255.9 5,587.3 5,918.9 6,250.7 6,582.7 6,914.7 7,246.9
8 0.40 0.38 4,120.0 4,466.7 4,813.8 5,161.3 5,509.1 5,857.1 6,205.4 6,553.8 6,902.4 7,251.2 7,600.0
9 0.44 0.42 4,272.7 4,633.0 4,993.7 5,354.8 5,716.3 6,077.9 6,439.8 6,801.9 7,164.1 7,526.4 7,888.9
10 0.10 0.06 1,880.0 2,081.5 2,282.8 2,483.9 2,684.8 2,885.7 3,086.5 3,287.2 3,487.8 3,688.4 3,888.9
11 0.12 0.08 600.0 685.2 770.1 854.8 939.4 1,023.8 1,108.1 1,192.3 1,276.4 1,360.5 1,444.4
12 0.16 0.12 1,000.0 1,060.2 1,120.7 1,181.5 1,242.4 1,303.6 1,364.9 1,426.3 1,487.8 1,549.4 1,611.1
13 0.20 0.16 1,960.0 2,107.4 2,255.2 2,403.2 2,551.5 2,700.0 2,848.6 2,997.4 3,146.3 3,295.3 3,444.4
14 0.24 0.20 2,600.0 2,805.6 3,011.5 3,217.7 3,424.2 3,631.0 3,837.8 4,044.9 4,252.0 4,459.3 4,666.7
15 0.30 0.26 3,240.0 3,503.7 3,767.8 4,032.3 4,297.0 4,561.9 4,827.0 5,092.3 5,357.7 5,623.3 5,888.9
16 0.36 0.32 3,666.7 3,969.1 4,272.0 4,575.3 4,878.8 5,182.5 5,486.5 5,790.6 6,094.9 6,399.2 6,703.7
17 0.40 0.36 3,880.0 4,201.9 4,524.1 4,846.8 5,169.7 5,492.9 5,816.2 6,139.7 6,463.4 6,787.2 7,111.1
18 0.44 0.40 4,054.5 4,392.3 4,730.4 5,068.9 5,407.7 5,746.8 6,086.0 6,425.4 6,765.0 7,104.7 7,444.4

4000
2 2000
0
0 1 2 3 4 5 6 7 8 9 10 11
3 -2000
4 -4000
5
-6000
6
7
8 -8000
9
-10000
L

10 4000
2000
11
0
0 1 2 3 4 5 6 7 8 9 10 11
12
-2000
13
-4000
14
15 -6000
16
17
18
-8000
-10000
L

the Perspective of the Equity and Debt Owners

L NOI1 t
NPV I 1 t 12:5
1L k0 k0 kd L1 t

leverage. At small L values for many pairs of values k0 and kd (e.g., k0 (24 %) and
kd (22 %), k0 (30 %) and kd (28 %), and many others), there is an optimum in the
dependence of NPV(L ) at small L 2:
For higher values of k0 (and, respectively, kd), all curves NPV(L) lie below.
With growth of NOI, all curves NPV(L ) are shifted parallel upward.
passing through (most often), or not passing (more rarely) through, optimum in
the dependence of NPV(L ) at small L 2:
k k0 kd) correspond to higher-lying curves NPV(L ). With growth of NOI,
all curves NPV(L ) are shifted practically parallel upward.
3. At the constant values of kd, NPV practically always decreases with leverage;
optimum in the dependence of NPV(L) is absent.
point; the higher values of k0 (and higher values of k k0 kd) correspond to
lower-lying curves NPV(L ). With growth of NOI, all curves NPV(L ) are shifted
practically parallel upward (Table 12.5, Figs. 12.9 and 12.10).
12.2

L
k0 kd 0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0 4.5
1 0.08 0.06 10,000.0 9,042.4 8,200.0 7,470.8 6,838.1 6,285.7 5,800.0 5,369.9 4,986.7 4,643.1
2 0.10 0.08 7,600.0 7,022.2 6,475.9 5,981.9 5,539.4 5,142.9 4,786.5 4,465.0 4,173.7 3,908.7
3 0.14 0.12 4,857.1 4,619.8 4,353.8 4,093.7 3,848.1 3,619.0 3,406.4 3,209.1 3,025.9 2,855.6
4 0.18 0.16 3,333.3 3,239.7 3,098.0 2,945.9 2,795.0 2,649.4 2,510.5 2,378.9 2,254.4 2,136.8
5 0.24 0.22 2,000.0 2,004.3 1,950.0 1,876.4 1,796.1 1,714.3 1,633.3 1,554.4 1,477.9 1,404.2
6 0.30 0.28 1,200.0 1,250.2 1,238.0 1,203.0 1,158.2 1,109.2 1,058.6 1,007.7 957.4 907.9
7 0.36 0.34 666.7 742.0 753.2 740.0 715.6 685.7 652.9 618.8 584.2 549.5
8 0.40 0.38 400.0 486.3 507.7 504.2 488.9 467.5 442.9 416.4 389.0 361.2
9 0.44 0.42 181.8 276.2 305.3 309.0 300.6 285.7 267.2 246.6 224.8 202.3
10 0.10 0.06 7,600.0 6,409.2 5,472.7 4,726.5 4,120.3 3,619.0 3,198.0 2,839.4 2,530.5 2,261.7
11 0.12 0.08 6,000.0 5,192.2 4,515.8 3,954.3 3,484.1 3,085.7 2,744.4 2,449.0 2,191.0 1,963.6
12 0.16 0.12 4,000.0 3,587.9 3,200.0 2,855.4 2,552.4 2,285.7 2,050.0 1,840.5 1,653.3 1,485.2
13 0.20 0.16 2,800.0 2,577.8 2,337.9 2,111.0 1,903.0 1,714.3 1,543.2 1,388.0 1,246.8 1,118.0
14 0.24 0.20 2,000.0 1,883.3 1,729.4 1,573.3 1,424.6 1,285.7 1,157.1 1,038.4 928.7 827.3
15 0.30 0.26 1,200.0 1,171.3 1,091.6 998.6 904.0 812.0 724.2 641.2 563.0 489.4
16 0.36 0.32 666.7 686.5 649.0 592.9 530.8 467.5 405.3 345.0 287.2 232.0
17 0.40 0.36 400.0 441.0 422.2 382.9 335.6 285.7 235.5 186.1 138.2 92.0
18 0.44 0.40 181.8 238.6 233.9 207.2 171.4 131.9 91.0 50.2 10.1 28.9
(continued)
201
202

L
k0 kd 5.0 5.5 6.0 6.5 7.0 7.5 8.0 8.5 9.0 9.5 10.0
1 0.08 0.06 4,333.3 4,052.7 3,797.4 3,564.1 3,350.0 3,152.9 2,970.9 2,802.3 2,645.7 2,499.8 2,363.6
12
2 0.10 0.08 3,666.7 3,444.8 3,240.8 3,052.5 2,878.3 2,716.6 2,566.1 2,425.7 2,294.4 2,171.4 2,055.9
3 0.14 0.12 2,697.0 2,549.0 2,410.7 2,281.1 2,159.5 2,045.2 1,937.6 1,836.2 1,740.3 1,649.6 1,563.6
4 0.18 0.16 2,025.6 1,920.6 1,821.1 1,726.9 1,637.7 1,552.9 1,472.4 1,395.9 1,323.0 1,253.5 1,187.2
5 0.24 0.22 1,333.3 1,265.3 1,200.0 1,137.4 1,077.3 1,019.6 964.3 911.1 860.0 810.9 763.6
6 0.30 0.28 859.6 812.7 767.1 722.9 680.1 638.7 598.5 559.7 522.2 485.8 450.6
7 0.36 0.34 515.2 481.3 448.1 415.6 383.9 352.9 322.8 293.4 264.8 236.9 209.8
8 0.40 0.38 333.3 305.7 278.3 251.4 225.0 199.1 173.7 148.9 124.7 101.0 77.9
9 0.44 0.42 179.5 156.6 133.9 111.4 89.1 67.2 45.7 24.6 3.8 16.5 36.4
10 0.10 0.06 2,025.6 1,816.7 1,630.5 1,463.5 1,313.0 1,176.5 1,052.2 938.5 834.2 738.1 649.4
11 0.12 0.08 1,761.9 1,581.7 1,419.8 1,273.5 1,140.7 1,019.6 908.7 806.9 712.9 626.1 545.5
12 0.16 0.12 1,333.3 1,195.6 1,070.1 955.4 850.0 752.9 663.2 580.1 502.9 430.9 363.6
13 0.20 0.16 1,000.0 891.7 791.8 699.6 614.2 534.8 460.8 391.8 327.2 266.7 209.8
14 0.24 0.20 733.3 646.2 565.1 489.5 419.0 352.9 291.0 232.9 178.2 126.6 77.9
15 0.30 0.26 420.3 355.3 294.1 236.4 182.1 130.7 82.2 36.2 7.3 48.7 88.0
16 0.36 0.32 179.5 129.5 82.0 36.8 6.2 47.1 86.0 123.1 158.5 192.3 224.6
17 0.40 0.36 47.6 5.1 35.5 74.4 111.5 147.1 181.0 213.5 244.7 274.5 303.0
18 0.44 0.40 66.7 103.1 138.2 171.9 204.2 235.3 265.1 293.8 321.3 347.8 373.2
Fig. 12.9 Dependence of NPV(L), NOI=1200, t = 20%

NPV on leverage level at NPV
1 10000
8000
2
6000
3
4000
4
5 2000
6
7
8 0
9
0 1 2 3 4 5 6 7 8 9 10 11
-2000
L

7000
11 6000
5000
12 4000
3000
13
14 2000
15
1000
16
17
18
0
0 1 2 3 4 5 6 7 8 9 10 11
-1000
L

NOI1 t
NPV S1 L1 t 12:6
k0 k0 kd Lt

leverage; optimum in the dependence of NPV(L ) is absent.
point; the higher values of k0 (and, respectively, kd) correspond to lower-lying
curves NPV(L). With growth of k, the density of curves NPV(L ) increases.
2. At the constant values of k0, NPV decreases with leverage; optimum in the
dependence of NPV(L ) is absent. All curves NPV(L ) at the constant values of k0
are started (at L 0) from one point; the higher values of kd (and, respectively,
the lower values of k) correspond to higher-lying curves NPV(L ). With growth
of k, the density of curves NPV(L ) increases.
3. At the constant values of kd, NPV decreases with leverage; optimum in the
dependence of NPV(L ) is absent. All curves NPV(L ) at the constant values of k0
are started (at L 0) from one point; the higher values of k0 (and, respectively,
the higher values of k) correspond to lower-lying curves NPV(L ). With
decrease of NOI, the density of curves NPV(L ) increases, and they are shifted
down (Table 12.6, Figs. 12.11 and 12.12).
12.2

L
k0 kd 0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0 4.5
1 0.08 0.06 10,000.0 8,907.3 7,828.6 6,762.8 5,709.1 4,666.7 3,634.8 2,612.8 1,600.0 595.9
2 0.10 0.08 7,600.0 6,611.8 5,630.8 4,656.6 3,688.9 2,727.3 1,771.4 821.1 124.1 1,064.4
3 0.14 0.12 4,857.1 3,960.6 3,066.7 2,175.3 1,286.5 400.0 484.2 1,366.2 2,246.2 3,124.1
4 0.18 0.16 3,333.3 2,474.7 1,617.4 761.3 93.6 947.4 1,800.0 2,651.5 3,502.0 4,351.5
5 0.24 0.22 2,000.0 1,166.9 334.4 497.6 1,329.0 2,160.0 2,990.5 3,820.5 4,650.0 5,479.1
6 0.30 0.28 1,200.0 378.8 442.1 1,262.7 2,083.1 2,903.2 3,723.1 4,542.7 5,362.0 6,181.1
7 0.36 0.34 666.7 148.1 962.6 1,777.0 2,591.3 3,405.4 4,219.4 5,033.2 5,846.8 6,660.3
8 0.40 0.38 400.0 411.9 1,223.8 2,035.5 2,847.1 3,658.5 4,469.9 5,281.2 6,092.3 6,903.3
9 0.44 0.42 181.8 628.1 1,437.8 2,247.5 3,057.1 3,866.7 4,676.1 5,485.5 6,294.7 7,103.9
10 0.10 0.06 7,600.0 6,430.8 5,288.9 4,171.4 3,075.9 2,000.0 941.9 100.0 1,127.3 2,141.2
11 0.12 0.08 6,000.0 4,941.9 3,900.0 2,872.7 1,858.8 857.1 133.3 1,113.5 2,084.2 3,046.2
12 0.16 0.12 4,000.0 3,053.7 2,114.3 1,181.4 254.5 666.7 1,582.6 2,493.6 3,400.0 4,302.0
13 0.20 0.16 2,800.0 1,905.9 1,015.4 128.3 755.6 1,636.4 2,514.3 3,389.5 4,262.1 5,132.2
14 0.24 0.20 2,000.0 1,134.4 271.0 590.5 1,450.0 2,307.7 3,163.6 4,017.9 4,870.6 5,721.7
15 0.30 0.26 1,200.0 357.9 483.1 1,323.1 2,162.0 3,000.0 3,837.0 4,673.2 5,508.4 6,342.9
16 0.36 0.32 666.7 162.6 991.3 1,819.4 2,646.8 3,473.7 4,300.0 5,125.8 5,951.0 6,775.8
17 0.40 0.36 400.0 423.8 1,247.1 2,069.9 2,892.3 3,714.3 4,535.8 5,357.0 6,177.8 6,998.2
18 0.44 0.40 181.8 637.8 1,457.1 2,276.1 3,094.7 3,913.0 4,731.0 5,548.7 6,366.1 7,183.2
(continued)
205
206

L
k0 kd 5.0 5.5 6.0 6.5 7.0 7.5 8.0 8.5 9.0 9.5 10.0
1 0.08 0.06 400.0 1,388.2 2,369.2 3,343.4 4,311.1 5,272.7 6,228.6 7,178.9 8,124.1 9,064.4 10,000.0
12
2 0.10 0.08 2,000.0 2,931.1 3,858.1 4,781.0 5,700.0 6,615.4 7,527.3 8,435.8 9,341.2 10,243.5 11,142.9
3 0.14 0.12 4,000.0 4,874.1 5,746.3 6,616.9 7,485.7 8,352.9 9,218.6 10,082.8 10,945.5 11,806.7 12,666.7
4 0.18 0.16 5,200.0 6,047.5 6,894.1 7,739.8 8,584.6 9,428.6 10,271.7 11,114.0 11,955.6 12,796.3 13,636.4
5 0.24 0.22 6,307.7 7,135.9 7,963.6 8,791.0 9,617.9 10,444.4 11,270.6 12,096.4 12,921.7 13,746.8 14,571.4
6 0.30 0.28 7,000.0 7,818.6 8,637.0 9,455.2 10,273.2 11,090.9 11,908.4 12,725.7 13,542.9 14,359.8 15,176.5
7 0.36 0.34 7,473.7 8,286.9 9,100.0 9,913.0 10,725.8 11,538.5 12,351.0 13,163.5 13,975.8 14,787.9 15,600.0
8 0.40 0.38 7,714.3 8,525.1 9,335.8 10,146.5 10,957.0 11,767.4 12,577.8 13,388.0 14,198.2 15,008.2 15,818.2
9 0.44 0.42 7,913.0 8,722.1 9,531.0 10,339.9 11,148.7 11,957.4 12,766.1 13,574.7 14,383.2 15,191.6 16,000.0
10 0.10 0.06 3,142.9 4,133.3 5,113.5 6,084.2 7,046.2 8,000.0 8,946.3 9,885.7 10,818.6 11,745.5 12,666.7
11 0.12 0.08 4,000.0 4,946.3 5,885.7 6,818.6 7,745.5 8,666.7 9,582.6 10,493.6 11,400.0 12,302.0 13,200.0
12 0.16 0.12 5,200.0 6,094.1 6,984.6 7,871.7 8,755.6 9,636.4 10,514.3 11,389.5 12,262.1 13,132.2 14,000.0
13 0.20 0.16 6,000.0 6,865.6 7,729.0 8,590.5 9,450.0 10,307.7 11,163.6 12,017.9 12,870.6 13,721.7 14,571.4
14 0.24 0.20 6,571.4 7,419.7 8,266.7 9,112.3 9,956.8 10,800.0 11,642.1 12,483.1 13,323.1 14,162.0 15,000.0
15 0.30 0.26 7,176.5 8,009.3 8,841.4 9,672.7 10,503.4 11,333.3 12,162.6 12,991.3 13,819.4 14,646.8 15,473.7
16 0.36 0.32 7,600.0 8,423.8 9,247.1 10,069.9 10,892.3 11,714.3 12,535.8 13,357.0 14,177.8 14,998.2 15,818.2
17 0.40 0.36 7,818.2 8,637.8 9,457.1 10,276.1 11,094.7 11,913.0 12,731.0 13,548.7 14,366.1 15,183.2 16,000.0
18 0.44 0.40 8,000.0 8,816.5 9,632.8 10,448.8 11,264.5 12,080.0 12,895.2 13,710.2 14,525.0 15,339.5 16,153.8

1 10000
2
3 5000
4
5
6
7 0
8
90 1 2 3 4 5 6 7 8 9 10 11
-5000
-10000
-15000
-20000
L

10
11
5000
12
13
14
15
16
17 0
18
0 1 2 3 4 5 6 7 8 9 10 11
-5000
-10000
-15000
-20000
L

NOI1 t kd Dt
NPV I
0 WACC 1
L
B k t 12:7
1 L C NOI1 t
d
I B
@1
C
A :
L L
k0 1 t k0 1 t
1L 1L
1. At the constant values of k k0 kd , NPV demonstrates a limited growth with

leverage with output into saturation regime. The main increase in NPV occurs
when L 5 6. With growth of k0 (and kd), the urves NPV(L ) are lowered.
With growth of NOI, all curves NPV(L ) are shifted practically parallel
upward.
k0 and different values of kd are started (at L 0) from one point; the higher
values of kd (and, respectively, the lower values of k k0 kd) correspond to
higher-lying curves NPV(L ). Optimum in the dependence of NPV(L) is absent.
With growth of NOI, all curves NPV(L ) are shifted practically parallel upward.
3. At the constant values of kd, NPV shows a limited growth with leverage with
output into saturation regime. All curves NPV(L) at the constant values of k0 and
different values of kd are started (at L 0) from one point; the higher values of k0
(and, respectively, the higher values of k k0 kd) correspond to lower-lying
curves NPV(L ). Optimum in the dependence of NPV(L) is absent (Table 12.7,
Figs. 12.13 and 12.14).
12.2

L
k0 kd 0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0 4.5
1 0.08 0.06 10,000.0 10,964.3 11,500.0 11,840.9 12,076.9 12,250.0 12,382.4 12,486.8 12,571.4 12,641.3
2 0.10 0.08 7,600.0 8,400.0 8,844.4 9,127.3 9,323.1 9,466.7 9,576.5 9,663.2 9,733.3 9,791.3
3 0.14 0.12 4,857.1 5,469.4 5,809.5 6,026.0 6,175.8 6,285.7 6,369.7 6,436.1 6,489.8 6,534.2
4 0.18 0.16 3,333.3 3,841.3 4,123.5 4,303.0 4,427.4 4,518.5 4,588.2 4,643.3 4,687.8 4,724.6
5 0.24 0.22 2,000.0 2,416.7 2,648.1 2,795.5 2,897.4 2,972.2 3,029.4 3,074.6 3,111.1 3,141.3
6 0.30 0.28 1,200.0 1,561.9 1,763.0 1,890.9 1,979.5 2,044.4 2,094.1 2,133.3 2,165.1 2,191.3
7 0.36 0.34 666.7 992.1 1,172.8 1,287.9 1,367.5 1,425.9 1,470.6 1,505.8 1,534.4 1,558.0
8 0.40 0.38 400.0 707.1 877.8 986.4 1,061.5 1,116.7 1,158.8 1,192.1 1,219.0 1,241.3
9 0.44 0.42 181.8 474.0 636.4 739.7 811.2 863.6 903.7 935.4 961.0 982.2
10 0.10 0.06 7,600.0 8,371.4 8,800.0 9,072.7 9,261.5 9,400.0 9,505.9 9,589.5 9,657.1 9,713.0
11 0.12 0.08 6,000.0 6,666.7 7,037.0 7,272.7 7,435.9 7,555.6 7,647.1 7,719.3 7,777.8 7,826.1
12 0.16 0.12 4,000.0 4,535.7 4,833.3 5,022.7 5,153.8 5,250.0 5,323.5 5,381.6 5,428.6 5,467.4
13 0.20 0.16 2,800.0 3,257.1 3,511.1 3,672.7 3,784.6 3,866.7 3,929.4 3,978.9 4,019.0 4,052.2
14 0.24 0.20 2,000.0 2,404.8 2,629.6 2,772.7 2,871.8 2,944.4 3,000.0 3,043.9 3,079.4 3,108.7
15 0.30 0.26 1,200.0 1,552.4 1,748.1 1,872.7 1,959.0 2,022.2 2,070.6 2,108.8 2,139.7 2,165.2
16 0.36 0.32 666.7 984.1 1,160.5 1,272.7 1,350.4 1,407.4 1,451.0 1,485.4 1,513.2 1,536.2
17 0.40 0.36 400.0 700.0 866.7 972.7 1,046.2 1,100.0 1,141.2 1,173.7 1,200.0 1,221.7
18 0.44 0.40 181.8 467.5 626.3 727.3 797.2 848.5 887.7 918.7 943.7 964.4
(continued)
209
210

L
k0 kd 5.0 5.5 6.0 6.5 7.0 7.5 8.0 8.5 9.0 9.5 10.0
1 0.08 0.06 12,700.0 12,750.0 12,793.1 12,830.6 12,863.6 12,892.9 12,918.9 12,942.3 12,963.4 12,982.6 13,000.0
12
2 0.10 0.08 9,840.0 9,881.5 9,917.2 9,948.4 9,975.8 10,000.0 10,021.6 10,041.0 10,058.5 10,074.4 10,088.9
3 0.14 0.12 6,571.4 6,603.2 6,630.5 6,654.4 6,675.3 6,693.9 6,710.4 6,725.3 6,738.7 6,750.8 6,761.9
4 0.18 0.16 4,755.6 4,781.9 4,804.6 4,824.4 4,841.8 4,857.1 4,870.9 4,883.2 4,894.3 4,904.4 4,913.6
5 0.24 0.22 3,166.7 3,188.3 3,206.9 3,223.1 3,237.4 3,250.0 3,261.3 3,271.4 3,280.5 3,288.8 3,296.3
6 0.30 0.28 2,213.3 2,232.1 2,248.3 2,262.4 2,274.7 2,285.7 2,295.5 2,304.3 2,312.2 2,319.4 2,325.9
7 0.36 0.34 1,577.8 1,594.7 1,609.2 1,621.9 1,633.0 1,642.9 1,651.7 1,659.5 1,666.7 1,673.1 1,679.0
8 0.40 0.38 1,260.0 1,275.9 1,289.7 1,301.6 1,312.1 1,321.4 1,329.7 1,337.2 1,343.9 1,350.0 1,355.6
9 0.44 0.42 1,000.0 1,015.2 1,028.2 1,039.6 1,049.6 1,058.4 1,066.3 1,073.4 1,079.8 1,085.6 1,090.9
10 0.10 0.06 9,760.0 9,800.0 9,834.5 9,864.5 9,890.9 9,914.3 9,935.1 9,953.8 9,970.7 9,986.0 10,000.0
11 0.12 0.08 7,866.7 7,901.2 7,931.0 7,957.0 7,979.8 8,000.0 8,018.0 8,034.2 8,048.8 8,062.0 8,074.1
12 0.16 0.12 5,500.0 5,527.8 5,551.7 5,572.6 5,590.9 5,607.1 5,621.6 5,634.6 5,646.3 5,657.0 5,666.7
13 0.20 0.16 4,080.0 4,103.7 4,124.1 4,141.9 4,157.6 4,171.4 4,183.8 4,194.9 4,204.9 4,214.0 4,222.2
14 0.24 0.20 3,133.3 3,154.3 3,172.4 3,188.2 3,202.0 3,214.3 3,225.2 3,235.0 3,243.9 3,251.9 3,259.3
15 0.30 0.26 2,186.7 2,204.9 2,220.7 2,234.4 2,246.5 2,257.1 2,266.7 2,275.2 2,282.9 2,289.9 2,296.3
16 0.36 0.32 1,555.6 1,572.0 1,586.2 1,598.6 1,609.4 1,619.0 1,627.6 1,635.3 1,642.3 1,648.6 1,654.3
17 0.40 0.36 1,240.0 1,255.6 1,269.0 1,280.6 1,290.9 1,300.0 1,308.1 1,315.4 1,322.0 1,327.9 1,333.3
18 0.44 0.40 981.8 996.6 1,009.4 1,020.5 1,030.3 1,039.0 1,046.7 1,053.6 1,059.9 1,065.5 1,070.7

12000
2 10000
8000
3
6000
4
4000
5
6 2000
7
8
9
0
0 1 2 3 4 5 6 7 8 9 10 11
L

10 10000
11 8000
6000
12
13 4000
14
15
16 2000
17
18
0
0 1 2 3 4 5 6 7 8 9 10 11
L

kd Lt NOI1 t
NPV S 1 L ; 12:8
WACC WACC
2 3
k Lt S1 L1 t
NPV S41 L 5 :
d
12:9
k0 1 1L L
t k0 1 1L
L
t
1. At the constant values of k k0 kd , NPV shows as an unlimited growth with

credit rate value kd 8 % turns out to be a border at all surveyed values of
leverage from descending of NPV with leverage). In other words, with growth of
kd, the transition from the growth of NPV with leverage to its descending with
leverage takes place, and at the credit rate kd 8 %, NPV does not depend on
the leverage level at all surveyed values of k0.
Thus, we come to conclusion that for perpetuity projects, NPV grows with
leverage at a credit rate kd < 8 %, and NPV decreases with leverage at a credit
rate kd > 8 % (the project remains effective up to leverage levels L L0 , NPV
L0 0). Optimum in the dependence of NPV(L) is absent.
2. At the constant values of kd, NPV shows an unlimited growth with leverage as
well as unlimited descending with leverage. NPV grows with leverage at a credit
rate kd < 8 10 %, and NPV decreases with leverage at a credit rate kd < 8
10 % (the project remains effective up to leverage levels L L0 , NPVL0
0). All curves NPV(L ) at the constant values of k0 and different values of kd
are started (at L 0) from one point; the higher values of k0 (and higher values of
k k0 kd ) correspond to more low-lying curves NPV(L ). Optimum in
dependence of NPV(L ) is absent.
3. At the constant values of k0, NPV as well as in the case of constant values of
k k0 kd shows mainly an unlimited growth with leverage. Unlimited
descending with leverage was shown for the pair k0 10 %; kd 8 % only.
All curves NPV(L) at the constant values of k0 and different values of kd are
k k0 kd ) correspond to more high-lying curves NPV(L ). Optimum in
dependence of NPV(L ) is absent (Table 12.8, Figs. 12.15 and 12.16).
12.2

L
k0 kd 0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0 4.5
1 0.08 0.06 0.0 187.5 388.9 596.6 807.7 1,020.8 1,235.3 1,450.7 1,666.7 1,883.2
2 0.10 0.08 200.0 128.6 44.4 45.5 138.5 233.3 329.4 426.3 523.8 621.7
3 0.14 0.12 428.6 489.8 539.7 584.4 626.4 666.7 705.9 744.4 782.3 819.9
4 0.18 0.16 555.6 690.5 814.8 934.3 1,051.3 1,166.7 1,281.0 1,394.7 1,507.9 1,620.8
5 0.24 0.22 666.7 866.1 1,055.6 1,240.5 1,423.1 1,604.2 1,784.3 1,963.8 2,142.9 2,321.6
6 0.30 0.28 733.3 971.4 1,200.0 1,424.2 1,646.2 1,866.7 2,086.3 2,305.3 2,523.8 2,742.0
7 0.36 0.34 777.8 1,041.7 1,296.3 1,546.7 1,794.9 2,041.7 2,287.6 2,532.9 2,777.8 3,022.3
8 0.40 0.38 800.0 1,076.8 1,344.4 1,608.0 1,869.2 2,129.2 2,388.2 2,646.7 2,904.8 3,162.5
9 0.44 0.42 818.2 1,105.5 1,383.8 1,658.1 1,930.1 2,200.8 2,470.6 2,739.8 3,008.7 3,277.2
10 0.10 0.06 200.0 150.0 88.9 22.7 46.2 116.7 188.2 260.5 333.3 406.5
11 0.12 0.08 333.3 357.1 370.4 378.8 384.6 388.9 392.2 394.7 396.8 398.6
12 0.16 0.12 500.0 616.1 722.2 823.9 923.1 1,020.8 1,117.6 1,213.8 1,309.5 1,404.9
13 0.20 0.16 600.0 771.4 933.3 1,090.9 1,246.2 1,400.0 1,552.9 1,705.3 1,857.1 2,008.7
14 0.24 0.20 666.7 875.0 1,074.1 1,268.9 1,461.5 1,652.8 1,843.1 2,032.9 2,222.2 2,411.2
15 0.30 0.26 733.3 978.6 1,214.8 1,447.0 1,676.9 1,905.6 2,133.3 2,360.5 2,587.3 2,813.8
16 0.36 0.32 777.8 1,047.6 1,308.6 1,565.7 1,820.5 2,074.1 2,326.8 2,578.9 2,830.7 3,082.1
17 0.40 0.36 800.0 1,082.1 1,355.6 1,625.0 1,892.3 2,158.3 2,423.5 2,688.2 2,952.4 3,216.3
18 0.44 0.40 818.2 1,110.4 1,393.9 1,673.6 1,951.0 2,227.3 2,502.7 2,777.5 3,051.9 3,326.1
(continued)
213
214

L
k0 kd 5.0 5.5 6.0 6.5 7.0 7.5 8.0 8.5 9.0 9.5 10.0
1 0.08 0.06 2,100.0 2,317.1 2,534.5 2,752.0 2,969.7 3,187.5 3,405.4 3,623.4 3,841.5 4,059.6 4,277.8
12
2 0.10 0.08 720.0 818.5 917.2 1,016.1 1,115.2 1,214.3 1,313.5 1,412.8 1,512.2 1,611.6 1,711.1
3 0.14 0.12 857.1 894.2 931.0 967.7 1,004.3 1,040.8 1,077.2 1,113.6 1,149.8 1,186.0 1,222.2
4 0.18 0.16 1,733.3 1,845.7 1,957.9 2,069.9 2,181.8 2,293.7 2,405.4 2,517.1 2,628.7 2,740.3 2,851.9
5 0.24 0.22 2,500.0 2,678.2 2,856.3 3,034.3 3,212.1 3,389.9 3,567.6 3,745.2 3,922.8 4,100.3 4,277.8
6 0.30 0.28 2,960.0 3,177.8 3,395.4 3,612.9 3,830.3 4,047.6 4,264.9 4,482.1 4,699.2 4,916.3 5,133.3
7 0.36 0.34 3,266.7 3,510.8 3,754.8 3,998.7 4,242.4 4,486.1 4,729.7 4,973.3 5,216.8 5,460.3 5,703.7
8 0.40 0.38 3,420.0 3,677.3 3,934.5 4,191.5 4,448.5 4,705.4 4,962.2 5,218.9 5,475.6 5,732.3 5,988.9
9 0.44 0.42 3,545.5 3,813.6 4,081.5 4,349.3 4,617.1 4,884.7 5,152.3 5,419.9 5,687.4 5,954.8 6,222.2
10 0.10 0.06 480.0 553.7 627.6 701.6 775.8 850.0 924.3 998.7 1,073.2 1,147.7 1,222.2
11 0.12 0.08 400.0 401.2 402.3 403.2 404.0 404.8 405.4 406.0 406.5 407.0 407.4
12 0.16 0.12 1,500.0 1,594.9 1,689.7 1,784.3 1,878.8 1,973.2 2,067.6 2,161.9 2,256.1 2,350.3 2,444.4
13 0.20 0.16 2,160.0 2,311.1 2,462.1 2,612.9 2,763.6 2,914.3 3,064.9 3,215.4 3,365.9 3,516.3 3,666.7
14 0.24 0.20 2,600.0 2,788.6 2,977.0 3,165.3 3,353.5 3,541.7 3,729.7 3,917.7 4,105.7 4,293.6 4,481.5
15 0.30 0.26 3,040.0 3,266.0 3,492.0 3,717.7 3,943.4 4,169.0 4,394.6 4,620.1 4,845.5 5,070.9 5,296.3
16 0.36 0.32 3,333.3 3,584.4 3,835.2 4,086.0 4,336.7 4,587.3 4,837.8 5,088.3 5,338.8 5,589.1 5,839.5
17 0.40 0.36 3,480.0 3,743.5 4,006.9 4,270.2 4,533.3 4,796.4 5,059.5 5,322.4 5,585.4 5,848.3 6,111.1
18 0.44 0.40 3,600.0 3,873.7 4,147.3 4,420.8 4,694.2 4,967.5 5,240.8 5,514.0 5,787.1 6,060.3 6,333.3

1 4000
2000
2
0
0 1 2 3 4 5 6 7 8 9 10 11
3
-2000
4
-4000
5
6
7
8 -6000
9
-8000
L

10
1000
0
0 1 2 3 4 5 6 7 8 9 10 11 11
-1000
-2000
12
-3000
13
-4000
14
-5000
15
16 -6000
17
18
-7000
L
References
(11):815824
doi:10.1080/23322039.2014.946150
perpetuity limit Modigliani Miller theory. J Rev Global Econ 3:175185
Econ Rev 53:147175
odigliani F, iller M (1966) Some estimates of the cost of capital to the electric utility industry
19541957. Am Econ Rev 56:333391
Chapter 13
The Analysis of the Exploration of Efficiency
of Investment Projects of Arbitrary Duration
(Within BrusovFilatovaOrekhova Theory)
In the previous chapter, we have conducted the analysis of effectiveness of invest-

ment projects within the perpetuity (ModiglianiMiller) approximation
(odigliani and iller 1958, 1963, 1966). In this chapter the analysis of the
obtained results on the exploration of efficiency of investment projects of arbitrary
duration [within BrusovFilatovaOrekhova theory (Brusov and Filatova 2011;
2011)] is conducted.


For NPV in this case, the following expression has been obtained (Brusov and
Filatova 2011; Brusov et al. 2011a, b, c, 2012a, b, 2013a, b, 2014a, b; Brusova
2011) (Table 13.1; Figs. 13.1 and 13.2):

I 1 1
NPV 1 L 1 t 1 n
1L 1 kd 1 k d n
13:1
NOI1 t 1
1 :
ke 1 k e n

DOI 10.1007/978-3-319-14732-1_13
Table 13.1 N 2, t 0.2, NOI 1,200; I 1,000, k0kd const
218
L
k0 kd 0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0 4.5
1 0.08 0.06 711.9 700.7 686.2 670.6 654.6 638.5 622.4 606.5 590.8 575.3
2 0.10 0.08 666.6 660.2 649.4 637.0 623.9 610.5 597.0 583.6 570.2 556.9
13
3 0.14 0.12 580.9 581.9 576.5 568.5 559.4 549.6 539.5 529.3 519.0 508.7
4 0.18 0.16 503.0 510.6 509.8 505.7 499.9 493.4 486.3 478.9 471.3 463.7
5 0.24 0.22 398.5 414.0 418.6 418.9 417.1 414.0 410.2 406.0 401.4 396.6
6 0.30 0.28 306.5 328.6 337.3 340.6 344.0 344.2 343.5 342.3 340.6 338.6
7 0.36 0.34 225.0 251.3 264.7 272.0 276.4 279.0 280.5 281.3 281.6 283.5
8 0.40 0.38 175.6 206.1 221.0 229.6 235.1 236.2 238.8 240.6 242.0 242.9
9 0.44 0.42 129.7 163.0 179.5 189.5 196.1 200.7 204.3 207.0 209.1 210.9
10 0.10 0.06 666.6 635.3 602.0 568.7 536.1 504.4 473.6 443.9 415.2 387.5
11 0.12 0.08 622.6 596.5 567.1 537.1 507.3 478.2 449.9 422.4 395.7 369.9
12 0.16 0.12 541.1 524.3 501.8 477.7 453.2 428.8 404.8 381.4 358.4 336.1
13 0.20 0.16 466.2 456.8 441.5 422.5 402.5 382.2 362.1 342.1 322.5 303.2
14 0.24 0.20 398.5 396.6 385.1 370.2 353.8 336.9 319.7 302.6 285.6 268.9
15 0.30 0.26 306.5 313.4 308.1 298.0 285.9 275.8 263.0 249.9 236.7 223.6
16 0.36 0.32 225.0 237.9 238.8 234.1 226.8 218.2 208.7 198.8 188.6 178.3
17 0.40 0.36 175.6 193.9 197.2 194.7 189.3 179.9 172.2 164.0 155.5 146.7
18 0.44 0.40 129.7 151.7 157.5 157.1 153.7 148.5 142.4 135.6 128.5 121.1
The Analysis of the Exploration of Efficiency of Investment Projects of. . .
L
13.1
k0 kd 5.0 5.5 6.0 6.5 7.0 7.5 8.0 8.5 9.0 9.5 10.0
1 0.08 0.06 560.0 544.9 530.1 515.5 501.1 487.0 473.1 459.4 445.9 432.7 419.7
2 0.10 0.08 543.7 525.7 512.5 499.5 486.6 474.0 461.5 449.2 437.1 425.1 413.4
3 0.14 0.12 498.4 488.2 478.0 468.0 458.0 448.1 438.3 428.6 419.0 409.5 400.1
4 0.18 0.16 455.9 448.2 440.4 432.6 424.9 417.2 409.6 402.0 394.4 386.9 379.5
5 0.24 0.22 391.7 386.6 381.5 376.3 371.1 365.9 360.7 355.4 350.2 345.0 339.8
6 0.30 0.28 336.3 334.0 331.5 328.9 326.2 323.4 320.7 317.8 315.0 312.1 309.2
7 0.36 0.34 284.4 280.7 280.0 279.1 278.2 277.2 276.1 274.9 273.7 272.5 271.2
8 0.40 0.38 243.5 244.0 244.2 244.3 244.3 244.2 244.0 243.7 243.4 243.1 242.7
9 0.44 0.42 212.4 213.6 214.6 215.5 216.3 217.0 217.6 218.2 218.6 219.1 219.4
10 0.10 0.06 360.7 334.8 309.8 285.6 262.2 239.6 217.7 196.5 176.0 156.1 136.9
11 0.12 0.08 344.9 320.6 297.2 274.5 252.5 231.1 210.5 190.4 171.0 152.2 133.9
12 0.16 0.12 314.4 293.2 272.7 252.7 233.3 214.4 196.0 178.1 160.8 143.9 127.4
13 0.20 0.16 284.4 266.0 248.1 230.6 213.5 196.8 180.5 164.6 149.1 134.0 119.3
14 0.24 0.20 252.4 236.2 220.4 204.9 189.7 174.9 160.3 146.1 132.2 118.6 105.3
15 0.30 0.26 210.6 197.7 185.0 172.5 160.1 148.0 136.1 124.4 112.9 101.6 90.5
16 0.36 0.32 168.0 155.9 145.7 140.4 127.2 117.2 107.4 97.7 88.1 78.7 69.4
17 0.40 0.36 137.9 129.0 120.2 111.3 102.6 93.9 85.2 76.7 68.3 59.9 51.7
18 0.44 0.40 113.6 106.0 98.3 90.7 83.0 75.4 67.9 60.4 53.0 45.6 38.3
219
220 13 The Analysis of the Exploration of Efficiency of Investment Projects of. . .

1 700
2
600
3
4 500
5 400
6 300
7
200
8
9
100
0
0 1 2 3 4 5 6 7 8 9 10 11
L

11
600
12
500
13
14 400
15 300
16
200
17
18
100
0
0 1 2 3 4 5 6 7 8 9 10 11
L
1. At the constant values of k k0 kd ; NPV decreases with leverage at low

values of k0 (up to 20 %) and grows at higher values of k0 (from 25 % to 30 %).
All curves NPV(L) are shifted down with growth of k0. At small leverage levels
L, there is an optimum in the dependence of NPV(L ).
Higher values of kd (at the same value of k0) correspond to higher-lying curves
NPV(L ). At small leverage levels L at high value of k0 (3640 %), there is an
optimum in the dependence of NPV(L).
Higher values of k0 (at the same value of kd) correspond to lower-lying curves
NPV(L ). At small leverage levels L for some pairs of values k0 and kd [e.g., k0
(18 %) and kd (16 %)], there is an optimum in the dependence of NPV(L ).
At the Constant Equity Value (S Const)
Filatova 2011; Brusov et al. 2011a, b, c, 2012a, b, 2013a, b, 2014a, b) (Table 13.2;
Figs. 13.3 and 13.4):

1 1
NPV S 1 L 1 t 1 n n
1 k d 1 kd 13:2
S1 L1 t 1
1 :
ke 1 k e n
Table 13.2 N 2, t 0.2, S 1,000; 0.7, k0kd const
222
L
k0 kd 0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0 4.5
1 0.08 0.06 1.4 7.3 23.6 50.0 86.1 131.8 186.8 250.8 323.5 404.7
2 0.10 0.08 27.8 41.4 63.8 94.9 134.4 182.1 237.9 301.5 372.8 451.5
13
3 0.14 0.12 77.8 107.4 143.9 187.3 237.3 294.0 357.0 426.4 501.9 583.5
4 0.18 0.16 123.2 167.5 217.2 272.2 332.3 397.5 467.8 542.9 623.0 707.8
5 0.24 0.22 184.2 249.1 317.6 389.7 465.4 544.7 627.4 713.6 803.2 896.1
6 0.30 0.28 237.9 321.3 407.4 496.3 583.0 674.4 767.7 862.9 960.2 1,059.3
7 0.36 0.34 285.4 386.7 487.6 589.6 692.5 796.5 901.4 1,007.3 1,114.3 1,216.1
8 0.40 0.38 314.2 424.8 535.9 647.5 759.5 877.3 990.8 1,104.8 1,219.3 1,334.3
9 0.44 0.42 341.0 461.4 581.9 702.4 822.9 943.5 1,064.0 1,184.7 1,305.3 1,426.0
10 0.10 0.06 27.8 64.5 121.8 198.6 293.5 405.7 534.0 677.6 835.6 1,007.3
11 0.12 0.08 53.5 97.1 159.8 240.6 338.4 452.2 581.2 724.6 881.6 1,051.5
12 0.16 0.12 101.1 157.8 231.0 319.7 423.1 540.6 671.4 814.8 970.3 1,137.3
13 0.20 0.16 144.7 214.6 296.8 393.4 502.8 624.4 757.7 902.1 1,057.2 1,222.4
14 0.24 0.20 184.2 265.3 358.6 463.6 579.9 706.9 844.3 991.6 1,148.5 1,314.5
15 0.30 0.26 237.9 335.4 443.1 560.7 688.0 818.1 960.5 1,111.1 1,269.5 1,435.4
16 0.36 0.32 285.4 399.1 519.3 647.0 782.0 924.2 1,073.2 1,229.0 1,391.2 1,559.8
17 0.40 0.36 314.2 436.2 565.0 700.4 842.1 995.4 1,150.0 1,310.5 1,476.8 1,648.7
18 0.44 0.40 341.0 471.9 608.7 751.3 899.4 1,053.0 1,212.0 1,376.1 1,545.3 1,719.4
L
13.1
k0 kd 5.0 5.5 6.0 6.5 7.0 7.5 8.0 8.5 9.0 9.5 10.0
1 0.08 0.06 494.2 591.7 697.1 810.2 930.6 1,058.3 1,193.0 1,334.6 1,482.9 1,637.7 1,798.8
2 0.10 0.08 537.5 649.7 752.6 862.5 979.1 1,102.3 1,232.0 1,367.9 1,510.0 1,658.0 1,811.9
3 0.14 0.12 671.0 764.3 863.3 967.9 1,077.9 1,193.3 1,314.0 1,439.8 1,570.7 1,706.5 1,847.2
4 0.18 0.16 797.3 891.4 990.0 1,093.1 1,200.7 1,312.5 1,428.6 1,548.9 1,673.4 1,801.8 1,934.3
5 0.24 0.22 992.4 1,092.0 1,194.8 1,300.8 1,410.0 1,522.3 1,637.8 1,756.3 1,877.8 2,002.3 2,129.7
6 0.30 0.28 1,160.4 1,263.4 1,368.4 1,475.2 1,583.8 1,694.4 1,806.8 1,921.0 2,037.0 2,154.9 2,274.5
7 0.36 0.34 1,320.0 1,441.0 1,551.9 1,663.7 1,776.6 1,890.4 2,005.2 2,120.9 2,237.6 2,355.3 2,473.9
8 0.40 0.38 1,449.8 1,565.7 1,682.1 1,799.0 1,916.3 2,034.1 2,152.4 2,271.2 2,390.5 2,510.2 2,630.3
9 0.44 0.42 1,546.7 1,667.4 1,788.2 1,909.0 2,029.8 2,150.6 2,271.5 2,392.4 2,513.3 2,634.2 2,755.2
10 0.10 0.06 1,191.8 1,388.5 1,596.8 1,816.0 2,045.5 2,284.9 2,533.7 2,791.3 3,057.4 3,331.6 3,613.4
11 0.12 0.08 1,233.5 1,427.2 1,631.8 1,846.9 2,071.9 2,306.4 2,549.9 2,801.9 3,062.1 3,330.1 3,605.5
12 0.16 0.12 1,315.2 1,503.5 1,701.8 1,909.6 2,126.4 2,352.0 2,585.8 2,827.5 3,076.8 3,333.3 3,596.8
13 0.20 0.16 1,397.5 1,581.9 1,775.2 1,977.2 2,187.4 2,405.4 2,631.1 2,864.1 3,104.0 3,350.7 3,603.9
14 0.24 0.20 1,489.3 1,672.5 1,863.9 2,063.1 2,269.8 2,483.7 2,704.6 2,932.2 3,166.3 3,406.6 3,653.0
15 0.30 0.26 1,608.7 1,789.0 1,976.2 2,169.9 2,370.1 2,576.4 2,788.8 3,006.9 3,230.7 3,459.9 3,694.4
16 0.36 0.32 1,734.5 1,922.0 2,108.6 2,279.8 2,491.2 2,694.0 2,902.0 3,115.0 3,332.9 3,555.6 3,782.8
17 0.40 0.36 1,826.0 2,008.5 2,196.3 2,389.1 2,586.7 2,789.2 2,996.3 3,207.9 3,424.0 3,644.3 3,868.9
18 0.44 0.40 1,898.3 2,082.0 2,270.2 2,463.0 2,660.1 2,861.5 3,067.1 3,276.7 3,490.4 3,708.0 3,929.4
223

fixed values of k0 and kd 0 1 2 3 4 5 6 7 8 9 10 11
-500
-1000
-1500
1
2
3
4 -2000
5
6
7 -2500
8
9
-3000
L

-500
-1000
-1500
-2000
-2500
-3000
10
1112
13 -3500
14
15
16
17 -4000
18
-4500
L
1. At the constant values of k k0 kd ; NPV, as a rule, decreases with leverage.

All curves NPV(L ) are shifted down with growth of k0, and sometimes at small
leverage level L values, there is an optimum in the dependence of NPV(L). As it
will be shown in Chap. 17 at the example with Nastcom Plus company, the
dependence of NPV(L ) strongly depends on the parameter value and can have
a marked optimum.
Higher values of kd (lower values of k k0 kd ) at the same value of k0
correspond to higher-lying curves NPV(L ). Like the previous paragraph, the
dependence of NPV(L ) strongly depends on the parameter value and can have
a marked optimum.
Higher values of k0 (higher values of k k0 kd ) at the same value of kd
correspond to lower-lying curves NPV(L ). At small leverage levels L for pro-
jects with durations above 2 years for some pairs of values k0 and kd [e.g., for
5-year and 7-year projects with k0 (8 %) and kd (6 %) and k0 (10 %) and kd
(6 %)], there is an optimum in the dependence of NPV(L ). This optimum could
be a marked one at other values of parameter .
13.1.2 Without Flow Separation

Figs. 13.5 and 13.6):

I kd 1 t 1 L
NPV 1L 1
1L WACC 1 WACCn 1 WACCn
NOI1 t 1
1 :
WACC 1 WACCn
13:3
226
L
k0 kd 0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0 4.5
1 0.08 0.06 711.9 740.5 752.6 759.1 763.1 765.8 767.8 769.2 770.4 771.3
2 0.10 0.08 666.6 699.5 713.0 720.2 724.6 727.5 729.6 731.1 732.3 733.3
13
3 0.14 0.12 580.9 621.2 637.3 645.7 650.7 654.0 656.3 658.1 659.4 660.4
4 0.18 0.16 503.0 549.5 567.7 577.0 582.5 586.1 588.6 590.4 591.8 592.9
5 0.24 0.22 398.5 452.1 472.8 483.1 489.1 492.9 495.6 497.5 498.9 500.0
6 0.30 0.28 306.5 365.7 387.9 398.9 405.6 409.6 412.3 414.2 415.6 416.7
7 0.36 0.34 225.0 287.8 311.9 323.5 330.0 334.1 336.8 338.8 340.2 341.3
8 0.40 0.38 175.6 241.2 265.5 277.3 283.8 287.6 290.3 292.3 293.7 294.7
9 0.44 0.42 129.7 197.2 222.0 233.9 240.4 244.5 247.1 248.9 250.3 251.3
10 0.10 0.06 666.6 706.0 723.5 733.3 739.5 743.8 746.9 749.3 751.2 752.7
11 0.12 0.08 622.6 666.0 684.8 695.2 701.8 706.2 709.5 712.0 713.9 715.5
12 0.16 0.12 541.1 591.1 612.2 623.6 630.6 635.4 638.8 641.4 643.4 645.0
13 0.20 0.16 466.2 521.6 545.1 557.3 564.7 569.7 573.2 575.9 577.9 579.5
14 0.24 0.20 398.5 458.5 482.8 495.6 503.3 508.4 512.0 514.6 516.7 518.3
15 0.30 0.26 306.5 371.9 397.7 411.0 418.9 424.4 428.1 430.7 432.8 434.4
16 0.36 0.32 225.0 293.7 321.3 335.1 343.2 348.5 352.1 354.7 356.7 358.2
17 0.40 0.36 175.6 247.1 274.7 288.6 296.7 301.5 305.1 307.7 309.7 311.2
18 0.44 0.40 129.7 202.9 231.0 244.9 253.0 258.1 261.6 264.1 265.9 267.4
L
13.1
k0 kd 5.0 5.5 6.0 6.5 7.0 7.5 8.0 8.5 9.0 9.5 10.0
1 0.08 0.06 772.1 772.7 773.2 773.7 774.1 774.4 774.7 775.0 775.2 775.4 775.6
2 0.10 0.08 734.1 734.4 734.9 735.4 735.8 736.1 736.5 736.7 737.0 737.2 737.4
3 0.14 0.12 661.3 661.9 662.5 663.0 663.4 663.8 664.1 664.4 664.7 664.9 665.1
4 0.18 0.16 593.7 594.4 595.0 595.5 596.0 596.3 596.7 597.0 597.2 597.4 597.6
5 0.24 0.22 500.9 501.6 502.2 502.7 503.2 503.5 503.8 504.1 504.4 504.6 504.8
6 0.30 0.28 417.6 418.3 418.9 419.4 419.8 420.1 420.4 420.7 420.9 421.1 421.3
7 0.36 0.34 342.2 342.7 343.3 343.7 344.1 344.4 344.7 344.9 345.1 345.3 345.4
8 0.40 0.38 295.5 296.2 296.7 297.1 297.5 297.8 298.0 298.2 298.4 298.6 298.7
9 0.44 0.42 252.0 252.6 253.1 253.5 253.8 254.1 254.3 254.5 254.7 254.8 254.9
10 0.10 0.06 754.0 755.1 755.9 756.7 757.4 758.0 758.5 759.0 759.4 759.7 760.1
11 0.12 0.08 716.8 717.8 718.7 719.5 720.2 720.8 721.3 721.8 722.2 722.6 722.9
12 0.16 0.12 646.3 647.4 648.4 649.2 649.8 650.4 651.0 651.4 651.8 652.2 652.6
13 0.20 0.16 580.9 582.0 582.9 583.7 584.3 584.9 585.5 585.9 586.3 586.7 587.0
14 0.24 0.20 519.6 520.7 521.6 522.4 523.1 523.6 524.1 524.6 525.0 525.4 525.7
15 0.30 0.26 435.6 436.7 437.6 438.3 438.9 439.5 440.0 440.4 440.8 441.1 441.4
16 0.36 0.32 359.4 360.3 361.2 362.1 362.6 363.1 363.5 363.9 364.2 364.5 364.8
17 0.40 0.36 312.4 313.4 314.2 314.9 315.4 315.9 316.4 316.7 317.1 317.3 317.6
18 0.44 0.40 268.5 269.4 270.2 270.8 271.3 271.8 272.2 272.5 272.8 273.1 273.3
227

NPV on leverage level at
900
800
1
2
700
3
4 600
5 500
6
400
7
8 300
9
200
100
0
0 1 2 3 4 5 6 7 8 9 10 11
L

11
700
12
13 600
14
500
15
400
16
17
300
18
200
100
0
0 1 2 3 4 5 6 7 8 9 10 11
L
1. At the constant values of k k0 kd ; NPV demonstrates a limited growth with

leverage with output into saturation regime. The main increase in NPV occurs at
small values of leverage levels L 3. With growth of k0 (and kd), the urves
NPV(L ) are lowered. Optimum in the dependence of NPV(L ) is absent.
k0 and different values of kd are started (at L 0) from one point, and the higher
lower-lying curves NPV(L ). Optimum in the dependence of NPV(L) is absent.
With growth of NOI, all curves NPV(L ) are shifted practically parallel upward.
It is of interest the crossing of individual curves NPV(L ) at certain leverage
levels. This means the equivalence of projects with different pairs of k0 and kd at
this leverage level [see, e.g., n 7; L 2.5; (k0 and kd) (18;14) and (24;10)].
3. At the constant values of kd, NPV shows a limited growth with leverage with
output into saturation regime. All curves NPV(L) at the constant values of k0 and
different values of kd are started (at L 0) from one point, and the higher values
of k0 (and, respectively, the higher values of k k0 kd) correspond to lower-
lying curves NPV(L ). Optimum in the dependence of NPV(L ) is absent. The
crossing of individual curves NPV(L ) at certain leverage levels (like point 2)
was not observed up to 10-year projects.
Figs. 13.7 and 13.8):

Lkd 1 t 1 L
NPV S 1 1 n
WACC 1 WACC 1 WACCn
13:4
S1 L1 t 1
1 :
WACC 1 WACCn
230
L
k0 kd 0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0 4.5
1 0.08 0.06 1.4 32.9 62.7 90.6 117.5 143.9 170.0 195.9 221.6 247.1
2 0.10 0.08 27.8 2.5 16.9 33.8 49.6 64.6 79.2 93.5 107.6 121.5
13
3 0.14 0.12 77.8 69.8 70.1 73.7 79.1 85.4 92.4 99.8 107.4 115.3
4 0.18 0.16 123.2 131.6 150.2 173.0 198.0 224.2 251.2 278.8 306.7 335.0
5 0.24 0.22 184.2 215.3 259.2 308.4 360.4 413.9 468.4 523.6 579.3 635.3
6 0.30 0.28 237.9 289.8 356.6 429.7 505.9 584.2 663.6 743.8 824.6 905.8
7 0.36 0.34 285.4 356.7 444.0 538.7 637.0 737.6 839.5 942.3 1,045.8 1,150.1
8 0.40 0.38 314.2 396.9 497.4 605.4 717.3 831.3 946.9 1,063.6 1,180.9 1,298.7
9 0.44 0.42 341.0 434.8 547.3 667.9 792.6 919.7 1,048.4 1,178.1 1,308.6 1,439.6
10 0.10 0.06 27.8 9.6 42.6 73.7 103.9 133.7 163.0 192.2 221.2 250.1
11 0.12 0.08 53.5 25.0 2.2 18.2 37.4 56.0 74.1 92.0 109.6 127.1
12 0.16 0.12 101.1 89.8 86.4 86.4 88.0 90.6 93.8 97.3 101.2 105.3
13 0.20 0.16 144.7 149.8 164.2 183.1 204.2 226.5 249.5 273.1 297.0 321.2
14 0.24 0.20 184.2 204.4 236.3 273.0 312.2 352.8 394.3 436.4 478.9 521.8
15 0.30 0.26 237.9 279.4 334.8 396.0 460.2 526.1 593.2 661.0 729.3 798.1
16 0.36 0.32 285.4 346.8 423.3 506.6 593.5 682.4 772.6 863.6 955.2 1,047.3
17 0.40 0.36 314.2 387.3 477.3 574.4 675.2 778.0 882.2 987.5 1,093.4 1,199.7
18 0.44 0.40 341.0 425.5 527.9 637.9 751.8 868.1 985.8 1,104.5 1,223.9 1,343.8
L
13.1
k0 kd 5.0 5.5 6.0 6.5 7.0 7.5 8.0 8.5 9.0 9.5 10.0
1 0.08 0.06 272.6 298.1 323.4 348.8 374.1 399.3 424.6 449.8 475.0 500.2 525.4
2 0.10 0.08 135.3 149.4 163.1 176.8 190.4 204.1 217.6 231.2 244.7 258.2 271.7
3 0.14 0.12 123.4 131.6 139.8 148.2 156.6 165.1 173.6 182.2 190.8 199.4 208.0
4 0.18 0.16 363.4 391.9 420.6 449.4 478.3 507.2 536.2 565.3 594.4 623.5 652.7
5 0.24 0.22 691.5 748.0 804.6 861.4 918.2 975.2 1,032.2 1,089.2 1,146.3 1,203.5 1,260.7
6 0.30 0.28 987.4 1,069.1 1,151.1 1,233.2 1,315.5 1,397.8 1,480.2 1,562.7 1,645.3 1,727.9 1,810.6
7 0.36 0.34 1,254.7 1,358.6 1,463.4 1,568.4 1,673.5 1,778.7 1,884.1 1,989.5 2,094.9 2,200.5 2,306.1
8 0.40 0.38 1,417.0 1,535.5 1,654.3 1,773.3 1,892.5 2,011.7 2,131.1 2,250.6 2,370.1 2,489.7 2,609.4
9 0.44 0.42 1,571.0 1,702.7 1,834.7 1,966.9 2,099.3 2,231.8 2,364.4 2,497.1 2,629.8 2,762.7 2,895.6
10 0.10 0.06 278.9 307.6 336.3 365.0 393.6 422.1 450.7 479.2 507.8 536.3 564.8
11 0.12 0.08 144.5 161.8 179.1 196.3 213.4 230.5 247.6 264.6 281.7 298.7 315.7
12 0.16 0.12 109.5 113.9 118.3 122.9 127.5 132.1 136.8 141.5 146.2 151.0 155.8
13 0.20 0.16 345.6 370.1 394.7 419.5 444.3 469.2 494.2 519.2 544.2 569.3 594.4
14 0.24 0.20 564.9 608.1 651.5 695.1 738.7 782.4 826.1 869.9 913.8 957.7 1,001.6
15 0.30 0.26 867.1 936.3 1,005.7 1,075.3 1,145.0 1,214.7 1,284.6 1,354.5 1,424.5 1,494.5 1,564.6
16 0.36 0.32 1,139.8 1,232.0 1,324.9 1,419.3 1,511.6 1,604.9 1,698.3 1,791.8 1,885.3 1,978.9 2,072.5
17 0.40 0.36 1,306.5 1,413.5 1,520.8 1,628.3 1,735.9 1,843.6 1,951.4 2,059.3 2,167.3 2,275.3 2,383.4
18 0.44 0.40 1,464.2 1,584.8 1,705.6 1,826.7 1,947.9 2,069.2 2,190.7 2,312.2 2,433.8 2,555.5 2,677.2
231

NPV(L), t = 20% NPV
1000
1 500
2
0
0 1 2 3 4 5 6 7 8 9 10 3 11
-500
4
-1000
5
-1500
6
-2000
7
-2500
8
9
-3000
-3500
L

1000
10 500
11
0
0 1 2 3 4 5 6 7 8 9 10 12 11
-500
13
14 -1000
-1500
15
-2000
16
17
-2500
18
-3000
L
1. At the constant values of k k0 kd ; NPV shows as an unlimited growth with

credit rate value kd 12 % turns out to be a boundary at all surveyed values of
leverage from descending of NPV with leverage) for 2-year projects. In other
words, with growth of kd, the transition from the growth of NPV with leverage to
its descending with leverage takes place, and at the credit rate kd 12 %; NPV
does not depend on the leverage level at all surveyed values of k0. For 5-year
projects, this boundary credit rate is equal to 1618 %, and for 7-year and
10-year projects, it is equal to 1215 %.
Thus, we come to a conclusion that for arbitrary duration projects NPV grows
with leverage at a credit rate kd < 12 18 %; and NPV decreases with leverage
at a credit rate kd > 12 18 % (project remains effective up to leverage levels
L L0 , NPVL0 0). Optimum in the dependence of NPV(L ) is absent.
2. At the constant values of kd, NPV shows two types of behavior: (a) an unlimited
growth with leverage and (b) NPV reaches maximum at relatively low leverage
level (L < 1) following then by an unlimited descend with leverage.
NPV grows with leverage at a credit rate kd < 8 10 %; and NPV decreases
with leverage at a credit rate kd < 8 10 % (project remains effective up to
leverage levels L L0 , NPVL0 0). All curves NPV(L) at the constant values
of k0 and different values of kd are started (at L 0) from one point, and the
higher values of k0 (and higher values of k k0 kd ) correspond to more
low-lying curves NPV(L ). Optimum in the dependence of NPV(L ) is absent.
This is observed for projects of all analyzed duration frames. The first type of
dependence of NPV(L ) has a place mainly for pairs of values k0 and kd up to 16
18 %, while the second type has a place for higher pairs of values k0 and kd
irrespectively of the duration of the project.
Thus, for the projects of all analyzed durations, the second type of
dependence of NPV(L ) has a place for kd 16 %; k0 18 % 24 %;
kd 20 %; k0 24 % 44 %; kd 24 %; k0 30 % 44 %; in the
case 2-year project, another pair (kd 12 %; k0 14 %) is added yet.
3. At the constant values of k0, NPV as well as in case of constant values of
k k0 kd shows as an unlimited growth with leverage and unlimited
descending with leverage. An analysis of the data leads to the same conclu-
sion that, in paragraph (1), at an arbitrary duration of a project, NPV is
growing with leverage at the credit rate kd < 18 %; and NPV decreases with
leverage at a credit rate kd < 18 % (project remains effective up to leverage
levels L L0 , NPVL0 0).
It should be noted that this pattern should be taken into account by the
regulator which should regulate normative base in such a way that credit rates,
which are associated with central bank basic rate, do not exceed, say, 18 %.
started (at L 0) from one point, and the higher values of kd (and lower values of
k k0 kd ) correspond to more low-lying curves NPV(L). Optimum in the


Figs. 13.9 and 13.10):

Lt 1 NOI1 t 1
NPV I 1 1 1 : 13:5
1L 1 k d n ke 1 k e n
13.2
L
k0 kd 0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0 4.5
1 0.08 0.06 711.9 700.7 686.2 670.6 654.6 638.5 622.4 606.5 590.8 575.3
2 0.10 0.08 666.6 660.2 649.4 637.0 623.9 610.5 597.0 583.6 570.2 556.9
3 0.14 0.12 580.9 581.9 576.5 568.5 559.4 549.6 539.5 529.3 519.0 508.7
4 0.18 0.16 503.0 510.6 509.8 505.7 499.9 493.4 486.3 478.9 471.3 463.7
5 0.24 0.22 398.5 414.0 418.6 418.9 417.1 414.0 410.2 406.0 401.4 396.6
6 0.30 0.28 306.5 328.6 337.3 340.6 344.0 344.2 343.5 342.3 340.6 338.6
7 0.36 0.34 225.0 251.3 264.7 272.0 276.4 279.0 280.5 281.3 281.6 283.5
8 0.40 0.38 175.6 206.1 221.0 229.6 235.1 236.2 238.8 240.6 242.0 242.9
9 0.44 0.42 129.7 163.0 179.5 189.5 196.1 200.7 204.3 207.0 209.1 210.9
10 0.10 0.06 666.6 635.3 602.0 568.7 536.1 504.4 473.6 443.9 415.2 387.5
11 0.12 0.08 622.6 596.5 567.1 537.1 507.3 478.2 449.9 422.4 395.7 369.9
12 0.16 0.12 541.1 524.3 501.8 477.7 453.2 428.8 404.8 381.4 358.4 336.1
13 0.20 0.16 466.2 456.8 441.5 422.5 402.5 382.2 362.1 342.1 322.5 303.2
14 0.24 0.20 398.5 396.6 385.1 370.2 353.8 336.9 319.7 302.6 285.6 268.9
15 0.30 0.26 306.5 313.4 308.1 298.0 285.9 275.8 263.0 249.9 236.7 223.6
16 0.36 0.32 225.0 237.9 238.8 234.1 226.8 218.2 208.7 198.8 188.6 178.3
17 0.40 0.36 175.6 193.9 197.2 194.7 189.3 179.9 172.2 164.0 155.5 146.7
18 0.44 0.40 129.7 151.7 157.5 157.1 153.7 148.5 142.4 135.6 128.5 121.1
(continued)
235
L
236
k0 kd 5.0 5.5 6.0 6.5 7.0 7.5 8.0 8.5 9.0 9.5 10.0
1 0.08 0.06 560.0 544.9 530.1 515.5 501.1 487.0 473.1 459.4 445.9 432.7 419.7
2 0.10 0.08 543.7 525.7 512.5 499.5 486.6 474.0 461.5 449.2 437.1 425.1 413.4
3 0.14 0.12 498.4 488.2 478.0 468.0 458.0 448.1 438.3 428.6 419.0 409.5 400.1
13
4 0.18 0.16 455.9 448.2 440.4 432.6 424.9 417.2 409.6 402.0 394.4 386.9 379.5
5 0.24 0.22 391.7 386.6 381.5 376.3 371.1 365.9 360.7 355.4 350.2 345.0 339.8
6 0.30 0.28 336.3 334.0 331.5 328.9 326.2 323.4 320.7 317.8 315.0 312.1 309.2
7 0.36 0.34 284.4 280.7 280.0 279.1 278.2 277.2 276.1 274.9 273.7 272.5 271.2
8 0.40 0.38 243.5 244.0 244.2 244.3 244.3 244.2 244.0 243.7 243.4 243.1 242.7
9 0.44 0.42 212.4 213.6 214.6 215.5 216.3 217.0 217.6 218.2 218.6 219.1 219.4
10 0.10 0.06 360.7 334.8 309.8 285.6 262.2 239.6 217.7 196.5 176.0 156.1 136.9
11 0.12 0.08 344.9 320.6 297.2 274.5 252.5 231.1 210.5 190.4 171.0 152.2 133.9
12 0.16 0.12 314.4 293.2 272.7 252.7 233.3 214.4 196.0 178.1 160.8 143.9 127.4
13 0.20 0.16 284.4 266.0 248.1 230.6 213.5 196.8 180.5 164.6 149.1 134.0 119.3
14 0.24 0.20 252.4 236.2 220.4 204.9 189.7 174.9 160.3 146.1 132.2 118.6 105.3
15 0.30 0.26 210.6 197.7 185.0 172.5 160.1 148.0 136.1 124.4 112.9 101.6 90.5
16 0.36 0.32 168.0 155.9 145.7 140.4 127.2 117.2 107.4 97.7 88.1 78.7 69.4
17 0.40 0.36 137.9 129.0 120.2 111.3 102.6 93.9 85.2 76.7 68.3 59.9 51.7
18 0.44 0.40 113.6 106.0 98.3 90.7 83.0 75.4 67.9 60.4 53.0 45.6 38.3

1 700
2
600
3
4 500
5 400
6 300
7
200
8
9
100
0
0 1 2 3 4 5 6 7 8 9 10 11
L

11
600
12
500
13
14 400
15 300
16
200
17
18
100
0
0 1 2 3 4 5 6 7 8 9 10 11
L
1. At the constant values of k k0 kd ; NPV, as a rule, reaches an optimum at

relatively low leverage level (L < 1) and then decreases with leverage. All
curves NPV(L ) for the same values of k0 are started at the same point, but
with growth of k k0 kd (respectively, decreasing of kd), they are shifted
into a region of lower values of NPV, and descending speed decreases with
leverage, and for not too high values of k0 and kd, curves NPV(L ) practically
output into saturation regime. For higher values of k0 and kd, saturation regime
does not occur, and after optimum (sometimes, but more seldom, without
optimum) falling trend is still present.
very rarely only (for individual values of k0 and kd) demonstrating the presence
of optimum at low leverage levels (L < 1) (it should be noted that, with the
increase of the duration of the project, the number of curves NPV(L ) having
optimum is growing while remaining to be not very large). All curves NPV(L ) at
the constant values of k0 and different values of kd are started (at L 0) from one
point, and the higher values of kd (and lower values of k k0 kd) correspond
to higher-lying curves NPV(L). Descending speed decreases with leverage.
3. At the constant values of kd, NPV practically always decreases with leverage,
and the existence of optimum at low leverage levels (L < 1) is a rare exception.
All curves NPV(L) at the constant values of k0 and different values of kd are
started (at L 0) from one point, and the higher values of k0 (and higher values
of k k0 kd ) correspond to lower-lying curves NPV(L ). Descending speed
increases with leverage.
Figs. 13.11 and 13.12):

1
NPV S 1 L tL 1
1 kd n

S1 L1 t 1
1 : 13:6
ke 1 ke n
13.2
L
k0 kd 0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0 4.5
1 0.08 0.06 1.4 7.3 23.6 50.0 86.1 131.8 186.8 250.8 323.5 404.7
2 0.10 0.08 27.8 41.4 63.8 94.9 134.4 182.1 237.9 301.5 372.8 451.5
3 0.14 0.12 77.8 107.4 143.9 187.3 237.3 294.0 357.0 426.4 501.9 583.5
4 0.18 0.16 123.2 167.5 217.2 272.2 332.3 397.5 467.8 542.9 623.0 707.8
5 0.24 0.22 184.2 249.1 317.6 389.7 465.4 544.7 627.4 713.6 803.2 896.1
6 0.30 0.28 237.9 321.3 407.4 496.3 583.0 674.4 767.7 862.9 960.2 1,059.3
7 0.36 0.34 285.4 386.7 487.6 589.6 692.5 796.5 901.4 1,007.3 1,114.3 1,216.1
8 0.40 0.38 314.2 424.8 535.9 647.5 759.5 877.3 990.8 1,104.8 1,219.3 1,334.3
9 0.44 0.42 341.0 461.4 581.9 702.4 822.9 943.5 1,064.0 1,184.7 1,305.3 1,426.0
10 0.10 0.06 27.8 64.5 121.8 198.6 293.5 405.7 534.0 677.6 835.6 1,007.3
11 0.12 0.08 53.5 97.1 159.8 240.6 338.4 452.2 581.2 724.6 881.6 1,051.5
12 0.16 0.12 101.1 157.8 231.0 319.7 423.1 540.6 671.4 814.8 970.3 1,137.3
13 0.20 0.16 144.7 214.6 296.8 393.4 502.8 624.4 757.7 902.1 1,057.2 1,222.4
14 0.24 0.20 184.2 265.3 358.6 463.6 579.9 706.9 844.3 991.6 1,148.5 1,314.5
15 0.30 0.26 237.9 335.4 443.1 560.7 688.0 818.1 960.5 1,111.1 1,269.5 1,435.4
16 0.36 0.32 285.4 399.1 519.3 647.0 782.0 924.2 1,073.2 1,229.0 1,391.2 1,559.8
17 0.40 0.36 314.2 436.2 565.0 700.4 842.1 995.4 1,150.0 1,310.5 1,476.8 1,648.7
18 0.44 0.40 341.0 471.9 608.7 751.3 899.4 1,053.0 1,212.0 1,376.1 1,545.3 1,719.4
(continued)
239
L
240
k0 kd 5.0 5.5 6.0 6.5 7.0 7.5 8.0 8.5 9.0 9.5 10.0
1 0.08 0.06 494.2 591.7 697.1 810.2 930.6 1,058.3 1,193.0 1,334.6 1,482.9 1,637.7 1,798.8
2 0.10 0.08 537.5 649.7 752.6 862.5 979.1 1,102.3 1,232.0 1,367.9 1,510.0 1,658.0 1,811.9
3 0.14 0.12 671.0 764.3 863.3 967.9 1,077.9 1,193.3 1,314.0 1,439.8 1,570.7 1,706.5 1,847.2
13
4 0.18 0.16 797.3 891.4 990.0 1,093.1 1,200.7 1,312.5 1,428.6 1,548.9 1,673.4 1,801.8 1,934.3
5 0.24 0.22 992.4 1,092.0 1,194.8 1,300.8 1,410.0 1,522.3 1,637.8 1,756.3 1,877.8 2,002.3 2,129.7
6 0.30 0.28 1,160.4 1,263.4 1,368.4 1,475.2 1,583.8 1,694.4 1,806.8 1,921.0 2,037.0 2,154.9 2,274.5
7 0.36 0.34 1,320.0 1,441.0 1,551.9 1,663.7 1,776.6 1,890.4 2,005.2 2,120.9 2,237.6 2,355.3 2,473.9
8 0.40 0.38 1,449.8 1,565.7 1,682.1 1,799.0 1,916.3 2,034.1 2,152.4 2,271.2 2,390.5 2,510.2 2,630.3
9 0.44 0.42 1,546.7 1,667.4 1,788.2 1,909.0 2,029.8 2,150.6 2,271.5 2,392.4 2,513.3 2,634.2 2,755.2
10 0.10 0.06 1,191.8 1,388.5 1,596.8 1,816.0 2,045.5 2,284.9 2,533.7 2,791.3 3,057.4 3,331.6 3,613.4
11 0.12 0.08 1,233.5 1,427.2 1,631.8 1,846.9 2,071.9 2,306.4 2,549.9 2,801.9 3,062.1 3,330.1 3,605.5
12 0.16 0.12 1,315.2 1,503.5 1,701.8 1,909.6 2,126.4 2,352.0 2,585.8 2,827.5 3,076.8 3,333.3 3,596.8
13 0.20 0.16 1,397.5 1,581.9 1,775.2 1,977.2 2,187.4 2,405.4 2,631.1 2,864.1 3,104.0 3,350.7 3,603.9
14 0.24 0.20 1,489.3 1,672.5 1,863.9 2,063.1 2,269.8 2,483.7 2,704.6 2,932.2 3,166.3 3,406.6 3,653.0
15 0.30 0.26 1,608.7 1,789.0 1,976.2 2,169.9 2,370.1 2,576.4 2,788.8 3,006.9 3,230.7 3,459.9 3,694.4
16 0.36 0.32 1,734.5 1,922.0 2,108.6 2,279.8 2,491.2 2,694.0 2,902.0 3,115.0 3,332.9 3,555.6 3,782.8
17 0.40 0.36 1,826.0 2,008.5 2,196.3 2,389.1 2,586.7 2,789.2 2,996.3 3,207.9 3,424.0 3,644.3 3,868.9
18 0.44 0.40 1,898.3 2,082.0 2,270.2 2,463.0 2,660.1 2,861.5 3,067.1 3,276.7 3,490.4 3,708.0 3,929.4

-500
-1000
-1500
1
2
3
4 -2000
5
6
7 -2500
8
9
-3000
L

-500
-1000
-1500
-2000
-2500
10 -3000
11
12
13 -3500
14
15
16
17 -4000
18
-4500
L
1. At the constant values of k k0 kd ; NPV always decreases with leverage

[existence of an optimum at relatively low leverage level (L < 1)] and practically
has not been observed. All curves NPV(L ) for the same values of k0 are started at
the same point, but with growth of k0 (and, respectively, the growth of kd), they
are shifted into a region of lower values of NPV, and descending speed increases
with leverage.
The values of k k0 kd , equal to 2, 4, 6, and 10 %, have been used.
With growth of k k0 kd ; a narrowing of the NPV(L) curve cluster takes
place (the width of the cluster is decreased), the difference between curves
becomes less and less, and at k 10 %; the curve cluster is practically
transformed into one wide line. The marked pattern has a place for projects of
all examined duration projects (2, 5, 7, 10 years).
2. At the constant values of k0, NPV always decreases with leverage. All curves
NPV(L ) for the same values of k0 are started at the same point, but with growth
of kd (and, respectively, decrease of k k0 kd), they are shifted into a region
of higher values of NPV, and descending speed decreases with leverage. The
width of the NPV(L ) curve cluster is decreased with the increase of the duration
of the project.
3. At the constant values of k0, NPV always decreases with leverage. All curves
NPV(L ) for the same values of k0 are started at the same point, but with growth
of k0 (and, respectively, increase of k k0 kd), they are shifted into a region
of lower values of NPV, and descending speed increases with leverage. The
width of the NPV(L ) curve cluster is decreased with the increase of the duration
of the project.
13.2.2 Without Flow Separation

For NPV in this case, the following expressions have been obtained (Brusov and
Figs. 13.13 and 13.14):

NOI1 t kd Dt 1
NPV I 1
WACC 1 WACCn
0 1
NOI1 t kd Dt B 1 C
NPV I B
@ 1 n C
A
L L
k0 1 1 k0 1
1L 1L
2 0 13
L
6 k t
1 L B C7
d 1
NPV I 6
41
B1
@ n C
A5
7
L L
k0 1 t 1 k0 1 t
10L 1 1L
13:7
NOI1 t B 1 C
B
@1 n C
A:
L L
k0 1 t 1 k0 1 t
1L 1L
13.2
L
k0 kd 0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0 4.5
1 0.08 0.06 711.9 731.8 741.8 747.8 751.9 754.8 757.0 758.6 760.0 761.1
2 0.10 0.08 666.6 692.1 705.0 712.9 718.1 721.9 724.7 726.9 728.7 730.2
3 0.14 0.12 580.9 615.9 633.9 644.7 652.0 657.3 661.2 664.3 666.7 668.8
4 0.18 0.16 503.0 546.2 568.4 581.9 590.9 597.5 602.4 606.2 609.3 611.8
5 0.24 0.22 398.5 451.5 478.8 495.5 506.8 514.9 521.0 525.7 529.5 532.7
6 0.30 0.28 306.5 367.3 398.7 417.7 431.7 441.1 448.3 453.9 458.4 462.0
7 0.36 0.34 225.0 291.2 326.7 348.5 363.2 373.8 381.8 388.1 393.1 397.6
8 0.40 0.38 175.6 246.0 283.0 305.8 321.2 331.5 340.0 346.7 352.1 356.6
9 0.44 0.42 129.7 203.1 241.7 265.6 281.7 293.4 302.3 309.2 314.8 319.4
10 0.10 0.06 666.6 686.0 695.8 701.8 705.7 708.6 710.7 712.4 713.7 714.8
11 0.12 0.08 622.6 647.4 660.0 667.6 672.7 676.3 679.1 681.2 682.9 684.3
12 0.16 0.12 541.1 575.2 592.7 603.2 610.3 615.4 619.3 622.3 624.7 626.6
13 0.20 0.16 466.2 507.9 530.4 543.6 552.4 558.8 563.6 567.3 570.3 572.8
14 0.24 0.20 398.5 447.3 472.4 487.7 498.0 505.5 511.1 515.4 518.9 521.8
15 0.30 0.26 306.5 363.6 393.1 411.0 423.0 432.8 439.5 444.7 448.9 452.3
16 0.36 0.32 225.0 287.9 321.6 342.3 356.3 366.3 373.9 379.9 384.6 388.5
17 0.40 0.36 175.6 243.0 278.3 300.1 314.8 324.5 332.7 339.1 344.2 348.4
18 0.44 0.40 129.7 200.3 237.4 260.2 275.8 287.0 295.5 302.1 307.4 311.8
(continued)
243
L
244
k0 kd 5.0 5.5 6.0 6.5 7.0 7.5 8.0 8.5 9.0 9.5 10.0
1 0.08 0.06 762.0 762.8 763.5 764.1 764.6 765.1 765.5 765.8 766.1 766.4 766.7
2 0.10 0.08 731.4 731.4 732.3 733.0 733.7 734.3 734.8 735.3 735.7 736.0 736.4
3 0.14 0.12 670.5 671.9 673.1 674.2 675.1 675.9 676.7 677.3 677.9 678.4 678.9
13
4 0.18 0.16 613.9 615.7 617.2 618.6 619.7 620.7 621.7 622.5 623.2 623.9 624.5
5 0.24 0.22 535.3 537.5 539.4 541.1 542.5 543.8 544.9 546.0 546.9 547.7 548.5
6 0.30 0.28 465.1 467.7 470.0 471.9 473.6 475.1 476.5 477.7 478.7 479.7 480.6
7 0.36 0.34 401.3 403.6 406.1 408.3 410.2 411.8 413.3 414.7 415.9 417.0 418.0
8 0.40 0.38 360.2 363.4 366.1 368.4 370.5 372.3 373.9 375.3 376.6 377.8 378.9
9 0.44 0.42 323.2 326.4 329.2 331.7 333.8 335.7 337.4 338.9 340.2 341.4 342.6
10 0.10 0.06 715.7 716.5 717.2 717.7 718.2 718.7 719.1 719.4 719.8 720.0 720.3
11 0.12 0.08 685.5 686.5 687.3 688.1 688.7 689.3 689.8 690.2 690.7 691.0 691.4
12 0.16 0.12 628.3 629.7 630.9 631.9 632.8 633.6 634.3 634.9 635.5 636.0 636.5
13 0.20 0.16 574.8 576.6 578.1 579.4 580.5 581.5 582.4 583.2 583.9 584.6 585.2
14 0.24 0.20 524.2 526.2 528.0 529.5 530.8 532.0 533.0 533.9 534.8 535.5 536.2
15 0.30 0.26 455.2 457.6 459.7 461.6 463.2 464.6 465.8 466.9 467.9 468.9 469.7
16 0.36 0.32 391.8 394.1 396.6 399.7 400.8 402.4 403.8 405.1 406.3 407.3 408.2
17 0.40 0.36 351.9 354.9 357.5 359.7 361.7 363.4 364.9 366.3 367.5 368.7 369.7
18 0.44 0.40 315.5 318.6 321.3 323.6 325.7 327.5 329.1 330.5 331.8 333.0 334.0

800
1
2
700
3
4
600
5
500
6
7 400
8
9
300
200
100
0
0 1 2 3 4 5 6 7 8 9 10 11
L

10
11 700
12
600
13
14
500
15
16 400
17
18
300
200
100
0
0 1 2 3 4 5 6 7 8 9 10 11
L
1. At the constant values of k k0 kd ; NPV demonstrates a limited growth with

leverage with output into saturation regime. The main increase in NPV occurs at
small values of leverage levels L 3 4. With growth of k0 (and kd), the urves
NPV(L ) are lowered. Optimum in the dependence of NPV(L ) is absent.
with output into saturation regime. The main increase in NPV occurs at low
values of leverage levels L 4 5. All curves NPV(L) at the constant values of
higher-lying curves NPV(L ). This distinguishes this case from consideration
from the point of view of equity capital owners, where ordering of curves NPV
(L ) with growth of kd is an opposite. Optimum in the dependence of NPV(L) is
absent. With growth of project duration, the distance between curves NPV(L),
corresponding to different pairs of values k0 and kd, increases.
3. At the constant values of kd, NPV demonstrates a limited growth with leverage
values of k0 (and, respectively, the higher values of k k0 kd) correspond to
lower-lying curves NPV(L ). With growth of k k0 kd ; the distance between
curves NPV(L), corresponding to different pairs of values k0 and kd, decreases.
Figs. 13.15 and 13.16):

kd Lt 1
NPV S 1 L 1 n
WACC 1 WACC
13:8
S1 L1 t 1
1 :
WACC 1 WACCn
13.2
L
k0 kd 0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0 4.5
1 0.08 0.06 1.4 19.8 41.1 62.5 83.9 105.3 126.8 148.2 169.7 191.1
2 0.10 0.08 27.8 13.6 1.0 15.6 30.3 45.1 59.9 74.7 89.5 104.3
3 0.14 0.12 77.8 77.7 77.0 76.1 75.1 74.0 72.9 71.8 70.6 69.4
4 0.18 0.16 123.2 136.4 148.8 160.8 172.6 184.3 196.0 207.6 219.2 230.7
5 0.24 0.22 184.2 216.3 247.1 277.3 307.3 337.1 366.8 396.5 426.1 455.7
6 0.30 0.28 237.9 287.3 335.2 382.5 427.6 473.6 519.5 565.3 611.0 656.7
7 0.36 0.34 285.4 351.6 414.4 476.2 537.6 598.7 659.6 720.4 781.2 840.5
8 0.40 0.38 314.2 389.7 462.5 534.1 605.1 677.6 748.0 818.3 888.5 958.6
9 0.44 0.42 341.0 426.0 508.0 588.6 668.7 748.3 827.7 906.9 986.0 1,065.1
10 0.10 0.06 27.8 20.4 12.7 5.1 2.7 10.4 18.2 26.0 33.7 41.5
11 0.12 0.08 53.5 52.8 51.9 50.9 49.9 48.8 47.6 46.5 45.4 44.2
12 0.16 0.12 101.1 113.6 125.5 137.3 148.9 160.5 172.0 183.5 195.0 206.5
13 0.20 0.16 144.7 170.2 193.6 217.4 241.0 264.6 288.1 311.5 334.9 358.3
14 0.24 0.20 184.2 221.2 257.1 292.6 327.8 362.9 397.9 432.9 467.8 502.7
15 0.30 0.26 237.9 291.7 344.2 396.1 447.8 496.9 547.6 598.2 648.7 699.2
16 0.36 0.32 285.4 355.6 422.6 488.7 554.4 619.8 685.1 750.3 815.5 880.5
17 0.40 0.36 314.2 393.4 470.1 545.7 620.8 697.6 772.2 846.6 920.9 995.2
18 0.44 0.40 341.0 429.5 515.1 599.6 683.5 767.0 850.3 933.4 1,016.4 1,099.3
(continued)
247
L
248
k0 kd 5.0 5.5 6.0 6.5 7.0 7.5 8.0 8.5 9.0 9.5 10.0
1 0.08 0.06 212.6 234.0 255.5 277.0 298.5 319.9 341.4 362.9 384.3 405.8 427.3
2 0.10 0.08 119.1 130.1 144.6 159.1 173.6 188.1 202.6 217.1 231.6 246.1 260.6
3 0.14 0.12 68.2 67.0 65.8 64.6 63.3 62.1 60.9 59.6 58.4 57.2 55.9
13
4 0.18 0.16 242.3 253.8 265.3 276.8 288.3 299.8 311.3 322.8 334.2 345.7 357.2
5 0.24 0.22 485.2 514.8 544.3 573.8 603.3 632.8 662.3 691.8 721.3 750.7 780.2
6 0.30 0.28 702.3 747.9 793.5 839.0 884.6 930.1 975.6 1,021.1 1,066.6 1,112.1 1,157.6
7 0.36 0.34 900.1 963.2 1,023.8 1,084.3 1,144.9 1,205.5 1,266.0 1,326.5 1,387.0 1,447.5 1,508.1
8 0.40 0.38 1,028.7 1,098.7 1,168.7 1,238.6 1,308.6 1,378.5 1,448.4 1,518.3 1,588.2 1,658.1 1,727.9
9 0.44 0.42 1,144.0 1,222.9 1,301.8 1,380.6 1,459.4 1,538.2 1,617.0 1,695.7 1,774.4 1,853.2 1,931.9
10 0.10 0.06 49.3 57.1 64.9 72.7 80.5 88.2 96.0 103.8 111.6 119.4 127.2
11 0.12 0.08 43.1 41.9 40.7 39.6 38.4 37.2 36.1 34.9 33.7 32.6 31.4
12 0.16 0.12 218.0 229.4 240.9 252.3 263.8 275.2 286.6 298.1 309.5 320.9 332.4
13 0.20 0.16 381.6 405.0 428.3 451.7 475.0 498.3 521.6 544.9 568.3 591.6 614.9
14 0.24 0.20 537.5 572.4 607.2 642.0 676.8 711.6 746.5 781.2 816.0 850.8 885.6
15 0.30 0.26 749.6 800.1 850.5 900.9 951.3 1,001.6 1,052.0 1,102.3 1,152.7 1,203.0 1,253.4
16 0.36 0.32 945.6 1,012.2 1,077.2 1,137.5 1,205.5 1,270.4 1,335.4 1,400.3 1,465.2 1,530.1 1,595.0
17 0.40 0.36 1,069.4 1,143.6 1,217.8 1,291.9 1,366.0 1,440.1 1,514.2 1,588.3 1,662.4 1,736.4 1,810.5
18 0.44 0.40 1,182.2 1,265.0 1,347.8 1,430.6 1,513.3 1,596.0 1,678.7 1,761.4 1,844.1 1,926.7 2,009.4

500
1
2
3 0
0 1 2 3 4 5 6 7 8 9 10 11
4
-500
5
-1000
6
7 -1500
8
9 -2000
-2500
L

10
11 0
0 1 2 3 4 5 6 7 8 9 10 11
12
-500
13
14
-1000
15
-1500
16
17
18 -2000
-2500
L
1. At the constant values of k k0 kd ; NPV shows as an unlimited growth with

leverage and unlimited descending with leverage. There is a boundary credit rate
value, which separates the growth of NPV with leverage from descending of
NPV with leverage. This rate depends on the values k k0 kd , equal to 2, 4,
6, and 10 %; weakly depends on project duration; and is within region 820 %.

Thus, we come to a conclusion that for arbitrary duration projects NPV grows
with leverage at a credit rate kd < 8 20 %; and NPV decreases with leverage
at a credit rate kd > 8 20 % (project remains effective up to leverage levels
L L0 , NPVL0 0). Optimum in the dependence of NPV(L ) is absent.
2. At the constant values of k0 (similar to the case of k k0 kd), NPV shows as
an unlimited growth with leverage and unlimited descending with leverage.
started (at L 0) from one point, and the higher values of kd (and lower values of
k k0 kd ) correspond to higher-lying curves NPV(L ). Optimum in the
3. At the constant values of kd, NPV as well as in the case of constant values of
k k0 kd shows as an unlimited growth with leverage and unlimited
descending with leverage. There is a boundary credit rate value, which sepa-
rates the growth of NPV with leverage from descending of NPV with leverage.
This rate depends on the values k k0 kd , equal to 2, 4, 6, and 10 %;
weakly depends on project duration; and is within region 820 %. Thus, we
come to a conclusion that for arbitrary duration projects NPV grows with
leverage at a credit rate kd < 8 20 %; and NPV decreases with leverage at a
credit rate kd > 8 20 % (project remains effective up to leverage levels
L L0 , NPVL0 0). Optimum in the dependence of NPV(L) is absent.
13.3 The Elaboration of Recommendations on the Capital

Structure of Investment of Enterprises, Companies,
Taking into Account All the Key Financial
Parameters of Investment Project
13.3.1 General Conclusions and Recommendations

on the Definition of Capital Structure of Investment
of Enterprises
As the dependence NPV(L) at different I, NOI, S, and indicates, the changing of

the first two parameters, as a rule, leads to the shift of curves NPV(L ) in the vertical
direction only (parallel offset), without changing of characteristic points of these
curves, and of type L* [value of L, where NPV(L ) reaches optimum (if available)].
Only the maximum permissible leverage level L0 is changed (in case of monotonic
descending of NPV with leverage).
This opens the way for tabulation of the results obtained in the case of constant
value of investment. In other words this fact is the basis for the use of our tables and
graphs to estimate the optimal debt level for the investor. Thus, obtained by us,
tables and graphs allow to determine value of L*, knowing only k0 and kd for
investment project. kd is the credit rate, which is determined by the creditor, but
13.3 The Elaboration of Recommendations on the Capital Structure of Investment. . . 251
determination of parameter k0 is always a complicated problem. This has been

noted by several researchers, and we can also add that the parameter k0 is one of the
most important parameters in both used theories: ModiglianiMiller (odigliani
and iller 1958, 1963, 1966) and BrusovFilatovaOrekhova (Brusov and Filatova
In contrast to the parameters I, NOI, a change of parameters S, , both individ-
ually and simultaneously, can significantly change the nature of the curves NPV(L),
i.e., the dependence of NPV on the leverage level. Thus, with change of NPV(L)
can be changed from decreasing function to function, having an optimum. Such
studies have been conducted on the example of Nastcom Plus company. This
means the inability of tabulation of the results obtained in the case of constant value
of equity capital S: in this case, one will need to use the formulas; we have received
to determine the NPV at the existing level leverage, as well as to optimize the
existing investment structure.
In the case of a constant invested capital I with the division of flows (with using
two discount rates) in the case of finite-duration projects, the descending of NPV
with leverage is possible, as well as the existence of optimum. Without flow
separation a moderate growth of NPV(L )output to saturationhas been
observed. This demonstrates the limitation of approach, associated with the use of
one discount rate, veiling various options of dependence of NPV(L ) at different
equity and debt cost.
At constant equity value S with the use of one discount rate (in WACC approx-
imation), one has either growth or decrease of NPV, depending on credit rate kd. We
have found the boundary rates kd, determining transition from growth to decrease of
NPV. Because application of two discount rates (at flow separation) demonstrates
the existence of optimum in this case, WACC approximation changes the type of
dependence of NPV(L).
Thus, one can make the following general recommendations:
1. It is necessary to use an assessment of the efficiency of investment projects with
flow separation.
2. In the case of a constant value of investment I, a tabulation of the obtained results
is possible, i.e., one can use obtained by us tables and graphs to estimate the
optimal for the investor level of borrowing. Thus, obtained by us, tables and
graphs allow to determine value of L*, knowing only k0 and kd for investment
project.
3. At a constant equity value S as well as to determine the NPV at the existing level
leverage and to estimate the optimal for the investor level of borrowing, received
by us, analytical expressions (formulas) should be used because the behavior of
NPV(L ) in this case depends strongly on S and .
References
(11):815824
doi:10.1080/23322039.2014.946150
Econ Rev 53:147175
19541957. Am Econ Rev 56:333391
Chapter 14
Investment Models with Uniform Debt
Repayment and Their Application
In previous chapters, we have established investment models with debt repayment

at the end of the project, well proven in the analysis of real investment projects. In
practice, however, a scheme of uniform debt repayment during the duration of the
project is more extended. In this chapter, we describe new investment models with
uniform debt repayment during the duration of the investment project, quite ade-
quately describing real investment projects. Within these models it is possible, in
particular, to analyze the dependence of effectiveness of investment projects on
debt financing and taxation. We will work on the modern theory of capital cost and
capital structure developed by BrusovFilatovaOrekhova (Brusov and Filatova
2011; Brusov et al. 2011a, b, c, 2012a, b, 2013a, b, 2014a, b; Filatova et al. 2008;
Brusova 2011) as well as on perpetuity limit (odigliani and iller 1958, 1963,
1966).
14.1 Investment Models with Uniform Debt Repayment
As in the case of debt repayment at the end of the project, the effectiveness of the
investment project is considered from two perspectives: the owners of equity and
debt and the equity holders only. In the first case, the interest and duty paid by
owners of equity (negative flows) returned to the project because they are exactly
equal to the flow (positive), obtained by owners of debt capital. The only effect of
leverage in this case is the effect of tax shield, generated from the tax relief: interest
on the loan is entirely included into the net cost and, thus, reduces the tax base. For
each of these cases, NPV is calculated in two ways: with the division of credit and
investment flows (and thus discounting the payments, using two different rates) and
without such a division (in this case, both flows are discounted at the same rate as
which, obviously, WACC can be chosen). For each of the four situations, two cases
are considered: (1) a constant value of equity S and (2) a constant value of the total
invested capital I S + D (D is value of debt funds).

DOI 10.1007/978-3-319-14732-1_14
254 14 Investment Models with Uniform Debt Repayment and Their Application
The main debt repayment occurs evenly (by equal parts) at the end of each
period, and the remaining debt at the end of the each period is an arithmetic
progression with the difference D=n

D 2D D n1 n2 D
D, D , D , ..., D, D ,D , ..., 14:1
n n n n n n
Interest constitutes a sequence:

n1 n2 D
kd D, kd D , kd D , . . . , kd : 14:2
n n n
In the case of consideration from the point of view of equity owners and debt
owners, the after-tax flow of capital for each period is equal to
NOI1 t kd Di t; 14:3
where
n i 1
Di D ; 14:4
n
and investments at time moment T 0 are equal to I S D. Here NOI stands

for net operating income (before tax).
In the second case (from the point of view of equity owners only), investments at
the initial moment T 0 are equal to S, and the flow of capital for the ith period
(apart from tax shields kdDt it includes payment of interest on the loan kd Di ) is
equal to
Di
NOI kd Di 1 t : 14:5
n
We suppose that the interest on the loan and the loans itself are paid in tranches kdDi
and D ni
n consequently during the all ith periods. We cite in Table 14.1 the
sequence of debt and interest values and credit values.
As in the case of debt repayment at the end of the project, we will consider two
different ways of discounting:
1. Operating and financial flows are not separated and both are discounted, using
the general rate (as which, obviously, the weighted average cost of capital
Table 14.1 The sequence of debt and interest values and credit values
Period number 1 2 3 ... n
Debt D D n1
n D n2
n
... D 1n
Interest kdD kd D n1
n kd D n2
n
... kd D 1n
(WACC) can be selected). For perpetuity projects, the ModiglianiMiller for-

mula (odigliani and iller 1963) for WACC will be used and for projects of
finite duration BrusovFilatovaOrekhova formula for WACC (Brusov and
Filatova 2011; Brusov et al. 2011a, b, c, 2012a, b, 2013a, b, 2014a, b; Filatova
et al. 2008).
2. Operating and financial flows are separated and are discounted at different rates:
the operating flow at the rate equal to the equity cost ke, depending on leverage,
and credit flowat the rate equal to the debt cost kd, which until fairly large
values of leverage remain constant and start to grow only at high values of
leverage L, when there is a danger of bankruptcy.
Note once again that loan capital is the least risky, because interest on credit
is paid after tax in the first place. Therefore, the cost of credit will always be less
than the equity cost, whether of ordinary or of preference shares ke > kd ; k p > kd .
Here ke; kp is equity cost of ordinary or of preference shares consequently.
One can show that the present value of interest can be calculated by using the
following formula, which we have been able to derive:
1 2 3 n a1 an n
2 3 n : 14:6
a a a a a 1 2 a 1an
Here a 1 i.
We will use this formula in the further calculations.

To obtain an expression for NPV, the discounted flow values for one period, given
by formulas (Eq. 14.3) and (Eq. 14.5), must be summed, using our obtained formula
(Eq. 14.6), in which a 1 i, where i is the discount rate. Its accurate assessment
is one of the most important advantages of BFO theory (BrusovFilatova
Orekhova) (Brusov and Filatova 2011; Brusov et al. 2011a, b, c, 2012a, b, 2013a,
b, 2014a, b; Filatova et al. 2008) over its perpetuity limitModiglianiMiller
theory (odigliani and iller 1958, 1963, 1966).
In this case, the expression for NPV has a view
n1i D
X n kd D
X 1 t
n
NOI1 t n n
NPV S
1 k e i
i1 i1 1 kd i
NOI1 t1 1 ke n
S
ke 14:7
D n1 1 1 kd n
kd D 1 t
n (n kd )
D 1 kd 1 1 kd n n
kd 1 t
n k2d k d 1 k d n
In perpetuity limit (let us call it ModiglianiMiller limit), one has
NOI1 t
NPV S D1 t: 14:8
ke
In this case, operating and financial flows are not separated and are discounted,
using the general rate (as which, obviously, WACC can be selected).
The main debt repayment, which occurs evenly (by equal parts) at the end of
each period, can be discounted either at the same rate WACC or at the debt cost rate
kd. Now we choose a uniform rate and the first option.
We still consider the effectiveness of the investment project from the perspective
of the equity holders only.
n1i D
n NOI1 t k d D
X 1 t
NPV S n n
i
i1 1 WACC
D n1
NOI1 t kd D 1 t 1

S n n 1
WACC 1 WACCn
n
kd D 1 WACC1 1 WACC
1 t 2
n WACC
n

WACC1 WACCn
14:9

NOI1 t kd D1 t
NPV S : 14:10
WACC

Projects of Arbitrary (Finite) Duration

In the case of consideration from the perspective of the owners of equity and debt
n1i
X
n
NOI1 t X
n kd D t
NPV I n
i
i1 1 ke i1 1 kd i
n
NOI1 t1 1 ke
I
ke 14:11
n1
D t 1 1 kd n
n( )
D 1 kd 1 1 kd n n
kd t
n k2d kd 1 kd n

NOI1 t
NOI I Dt: 14:12
ke
We still consider the effectiveness of the investment project from the perspective of
the owners of equity and debt.
n1i
n NOI1 t kd D
X t
NPV I n
i1 1 WACCi
n1
NOI1 t kd D t 1
I n 1 14:13
WACC 1 WACCn
kd D 1 WACC1 1 WACCn
t 2
n WACC

n

WACC1 WACCn

NOI1 t kd Dt
NPV I : 14:14
WACC
14.4 Example of the Application of the Derived Formulas
As an example of application of the obtained formulas, lets take a look at the

dependence of the NPV of project on the leverage level at three values of the tax on
profit rates in the case of consideration from the perspective of the equity holders
only without flows separation on operating and finance ones.
We use formula (Eq. 14.10) and the next parameters values
NOI 800; S 500; k0 22 %; kd 19 %; T 15 %; 20 %; 25 %:
Making the calculations in Excel, we get the data, which are shown in Fig. 14.1.
From the calculations and Fig. 14.1, one can make the following conclusions:
1. With growth of the tax on profit rate, the NPV of the project decreases and our
model makes it possible to assess, for how many percent, with growth of tax on
profit rate, for example, by 1 %.
It should be noted that the possibility of such evaluations is unique.
2. The effect of taxation on the NPV significantly depends on the leverage level:
With its increase, the impact of changing of tax on profit rate is greatly
reduced. This is valid for increasing of the tax on profit rate and for its reduction.
3. At tax on profit rates 20 % (as in Russia) and 25 %, there is an optimum in NPV
dependence on leverage. Investors should take into account the invested capital
structure: in this case, they may, without special effort (only changing this
structure), obtain (sometimes very substantial) gains in NPV. Note that at tax
NPV(L)
3000.00
2500.00
2000.00
NPV
1500.00
T=0,15
T=0,2
1000.00
T=0,25
500.00
0.00
0 1 2 3 4 5
L
Fig. 14.1 Dependence of NPV of the project on the leverage level at three values of the tax on
profit rates NOI 800; S 500; k0 22 %; kd 19 %; T 15 %; 20 %; 25 %
References 259
on profit rate 15 %, there is no optimum in NPV dependence on leverage: NPV

descends monotonically with leverage.
Conclusions New investment models with uniform debt repayment during the
duration of the project, quite adequately describing real investment projects, are
described. Within these models, it is possible, in particular, to analyze the depen-
dence of effectiveness of investment projects on debt financing and taxation. We
work on the modern theory of capital cost and capital structure developed by
BrusovFilatovaOrekhova as well as on perpetuity limitMM theory.
As in the case of debt repayment at the end of the project, the effectiveness of the
investment project is considered from two perspectives: the owners of equity and
debt and the equity holders only. For each of these cases, NPV is calculated in two
ways: with the division of credit and investment flows (and thus discounting the
payments, using two different rates) and without such a division (in this case, both
flows are discounted at the same rate as which, obviously, WACC can be chosen).
For each of the four situations, two cases are considered: (1) a constant value of
equity S and (2) a constant value of the total invested capital I S + D (D is value of
debt funds).
As an example of application of the obtained formulas, the dependence of the
NPV of project on the leverage level at three values of the tax on profit rate has been
investigated in the case of consideration from the perspective of the equity holders
only and without flows separation on operating and financial ones. It has been
shown that effect of taxation on the NPV significantly depends on the leverage
level: with its increase, the impact of changing of tax on profit rates is greatly
reduced. This is valid for increasing of the tax on profit rate and for its reduction.
The model allows investigating the dependence of effectiveness of the investment
project on leverage level, on the tax on profit rate, on credit rate, on equity cost, etc.
References
(11):815824

doi:10.1080/23322039.2014.946150
Econ Rev 53:147175
19541957. Am Econ Rev 56:333391
Chapter 15
Is It Possible to Increase Taxing
and Conserve a Good Investment Climate
in the Country?
Within investment models, developed by Brusov, Filatova, and Orekhova earlier

Filatova et al. 2008; Brusova 2011), the influence of tax on profit rate on effective-
ness of long-term investment projects at different debt levels is investigated. It is
shown that increase of tax on profit rate from one side leads to decrease of project
NPV, but from other side, it leads to decrease of sensitivity of NPV with respect to
leverage level. At high leverage level L, the influence of tax on profit rate increase
on effectiveness of investment projects becomes significantly less. We come to
conclusion, that taxing could be differentiated depending on debt level of invest-
ment projects of the company: for projects with high debt level L, it is possible, in
principle, to apply a higher tax on profit rate.
15.1 Influence of Tax on Profit Rates on the Efficiency

of the Investment Projects
The bases of the modern tax systems are the following taxes: tax on profit of
organizations, income tax (tax on the income of individuals), social tax (contribu-
tions into state extra budgetary funds), sales tax (the value-added tax), and tax on
property of the organization. In this chapter, we investigate the influence of tax on
profit rate on the efficiency of the investment projects.
The problems and those questions, which we are currently investigating and
analyzing now in all of their complexity and diversity and to which we give
answers, not be tractable by analysis and assessment previously, for which one
was not able to give an answer, they even are not raised in such a setting. What
should be the tax scale: flat, progressive or otherwise differentiated, and what
impact tax rate has on the cost of companys capital? What is the cumulative effect
of increase of taxes (whether the system stateentrepreneur will win or will lose

DOI 10.1007/978-3-319-14732-1_15
262 15 Is It Possible to Increase Taxing and Conserve a Good Investment Climate. . .
as a whole from the tax growth, and if it will lose, then how muchor whether the
redistribution of income in favor of the state does not destroy the spirit of enterprise,
its driving force)? If tax on profit rate will increase by 1 %, how much will the cost
of attractive capital of company increase and how much will its capitalization
decrease? If by 36 %, it should be serious reasons for such increase, but if by
0.51.5 %, it is possible to discuss such tax on profit rate increase.
How does taxation affect the efficiency of investment? How much will the NPV
of investment project decrease, if tax on profit rate will increase by 1 %? If on 5
10 %, it has a strong negative impact on investment, if on 1 %, or 0.5 %, or 0.25 %.
Regulator can accept this: this will help the state and does not exert much to
investment programs of companies.
One of the main reasons, for which it has become possible to carry out such
studies, has been a progress in corporate finance, made recently. It relates primarily
to the establishment of a modern theory of capital cost and capital structure by
Brusov, Filatova, and Orekhova (BFO theory) (Brusov and Filatova 2011; Brusov
et al. 2011a, b, c, 2012a, b, 2013a, b, 2014a, b; Filatova et al. 2008; Brusova 2011)
and to their creation of the framework of this theory of modern investment models.
The BFO theory allows to make correct assessment of the financial performance of
companies with arbitrary lifetime (arbitrary age) and of efficiency of investment
projects of arbitrary duration. This distinguishes BFO theory from odigliani
iller theory (odigliani and iller 1958, 1963, 1966), which is a perpetuity limit
of BFO theory. Archived, after the appearance of BFO theory, the odigliani
Miller theory, still heavily used in the West, despite of its obvious limitations, may,
in principle, be applied to long-living stable companies and long-term investment
projects. In its framework in this chapter, effects of taxation on the effectiveness of
long-term investment will be investigated.
So, at present, there are two main theories that allow to explore the effects of
taxation on the efficiency of investments: perpetuity ModiglianiMiller theory
(odigliani and iller 1958, 1963, 1966) and the modern theory of capital cost
and capital structure developed by Brusov, Filatova, and Orekhova (Brusov and
Filatova 2011; Brusov et al. 2011a, b, c, 2012a, b, 2013a, b, 2014a, b; Filatova
et al. 2008; Brusova 2011). In this chapter, we describe the first real results obtained
by us within investment models in perpetuity limit, which can be applied to long-
term projects.
The effectiveness of the investment project is considered from the perspectives
of the equity holders. For this case, NPV is calculated in two ways: with the division
of credit and investment flows (and thus discounting the payments, used two
different rates) and without such a division (in this case, both flows are discounted
at the same rate, as which, obviously, WACC can be chosen). For each of the four
situations, two cases are considered: (1) a constant value of equity S and (2) a
constant value of the total invested capital I S + D (D is value of debt funds).
We start first from the case with the division of credit and investment flows and
then consider the case without the division of flows.
15.2 Investment Models 263
15.2 Investment Models
Let us remind shortly the main points of the investment models with debt repay-
ment at the end of the project, well-proven in the analysis of real investment
projects.
Investments at the initial time moment T 0 are equal to S and the flow of
capital for the period (in addition to the tax shields kdDt, it includes a payment of
interest on a loan kd D).
NOI kd D1 t: 15:1
Here, for simplicity, we suppose that interest on the loan will be paid in equal shares
kdD during all periods. Note that principal repayment is made at the end of last
period.
Here NOI is net operating income (before taxes), kd is debt cost, and t is tax on
profit rate.
Let us first consider the case with the division of credit and investment flows. In
this case in perpetuity limit (ModiglianiMiller approximation), expression for
NPV takes the following form (Brusov and Filatova 2011; Brusov et al. 2011a, b,
c, 2012a, b, 2013a, b, 2014a, b; Filatova et al. 2008):
NOI1 t
NPV S D1 t: 15:2
ke
We will consider two cases:

1. A constant value of the total invested capital I S + D (D is value of debt funds)
2. A constant value of equity S
At a constant value of the total invested capital (I const), accounting
I NOI1 t
NPV 1 L1 t : 15:3
1L ke
I NOI1 t
NPV 1 L1 t ; 15:4
1L k0 k0 kd L1 t
where L D=S is leverage level, ke is equity cost of leverage company (which uses
the debt financing), and k0 is equity cost of non-leverage company (which does not
use the debt financing).
Under the transition from Eq. (15.3) to Eq. (15.4), we have used the dependence
of equity capital on leverage, received by odigliani and iller (1958, 1963,
1966):
Fig. 15.1 Dependence of NPV(L)

NPV on leverage level L at 3000.00
1
three values of tax on profit 2500.00
rate (1t 0.15; 2
2
t 0.20; 3t 0.25), 2000.00 3
NPV
NOI 800 1500.00
1000.00
500.00
0.00
0 2 4 6 8 10 12
L

NPV on leverage level 0.00
L at three values of tax on 0 2 4 6 8 10
-100.00
profit rate (1t 0.25; 2
t 0.20; 3t 0.15), -200.00
NOI 800, I 1,000
NPV
-300.00 1
-400.00
2
-500.00 3
-600.00
L
ke k0 k0 kd L1 t: 15:5
So we explore Eq. (15.4). A number of conclusions can be drawn from the study of
dependence of NPV of the project on leverage level at different values of tax on
profit rate t (Fig. 15.1). It is clear that the increase of tax on profit rate leads not only
to reduce of NPV of the project but also to decrease of the sensitivity of effective-
ness of investment project NPV to the leverage level L. At high leverage levels, the
influence of growth of tax on profit rate on the effectiveness of investment projects
is significantly reduced.
Hence, in particular, it should be noted that taxation can be differentiated
depending on the debt financing level in the company investment projects: for
projects with a high leverage level L, the higher tax on profit rates t can be used. The
foregoing is illustrated also in Fig. 15.2, where it is clear that the change of NPV
(NPV) with leverage level decreases when the tax on profit rate t grows and when
leverage level increases.
Let us increase our return on investment by 1.5 times (NOI 1,200 instead of
800) (Fig. 15.3). Still, the impact of the tax on profit rate on the NPV value
significantly depends on the level of debt financing. So the increase in tax on profit
rate by 1 % from the existing (in Russia t 20 %) leads to a reduction in the NPV by
44.5 units at L 0, by 27.7 units at L 1, by 12.2 units at L 3, and by 5 units at
L 5.
15.3 Borrowings Abroad 265

5000.00
NPV on leverage level L at 1
rate (1t 0.15; 2 4000.00 2
t 0.20; 3t 0.25), 3500.00 3
NOI 1,200, I 1,000 3000.00
NPV
2500.00
2000.00
1500.00
1000.00
500.00
0.00
0 1 2 3 4 5
L
Fig. 15.4 Dependence of D NPV(L)

L at three values of tax on -100.00 0 2 4 6 8 10
profit rate (1t 0.25; 2 -200.00
t 0.20; 3t 0.15),
-300.00
NOI 1,200, I 1,000
-400.00
DNPV
-500.00 1
-600.00
-700.00 2
-800.00
-900.00 3
L
That is, for companies with a high level of debt financing (e.g., companies in the
telecommunication sector and others), an increase in tax on profit rate will have less
impact on the effectiveness of their investment projects and will be less painful than
for companies with low leverage level in investment. It should be noted that the
increase of NOI by 1.5 times increases NPV by 1.7 times (from 2,555 up to 4,333)
and increases NPV(L ) by 1.62 at L 0 and by 1.5 times at L 9 (Fig. 15.4).
It is clear also that with the increase of the leverage level L, curves, describing
the dependence NPV(L ), virtually converge, which demonstrates once again the
reduction of impact of the change of the tax on profit rate t on the efficiency of
investment projects with the increase of the leverage level L.
15.3 Borrowings Abroad
Until recently, Russian companies have preferred to borrow abroad, because over-
seas credits are much cheaper than domestic ones. Although relevance of studies of
using such loans now is not so high in connection with the West sanctions, all same,
realizing that in the not-too-distant future, all will return to its circles; heres a
NPV(L)
8000.00
1
6000.00
NPV
4000.00
2000.00
2
0.00
0 2 4 6 8 10 12
L
Fig. 15.5 Comparison of dependences of NPV on leverage level L at typical values of credit rates
with borrowings abroad (1k0 0.1; kd 0.07) and with borrowings at domestic (Russian) credit
market (2k0 0.18; kd 0.14), NOI 800, I 1,000, t 15 %
NPV(L)
7000.00
6000.00
1
5000.00 2
3
4000.00
NPV
3000.00 4
5
2000.00 6
1000.00
0.00
0 2 4 6 8 10 12
L
Fig. 15.6 Influence of tax on profit rate on dependence of NPV on leverage level at typical values
of credit rates with borrowings abroad (lines 123) and with borrowings at domestic (Russian)
credit market (lines 456)
1k0 0.1; kd 0.07; t 0.15
2k0 0.1; kd 0.07; t 0.2
3k0 0.1; kd 0.07; t 0.25
4k0 0.18; kd 0.14; t 0.15
5k0 0.18; kd 0.14; t 0.2
6k0 0.18; kd 0.14; t 0.25
comparison of NPV dependencies on leverage at typical values of rates on credit,

with borrowings abroad (k0 0.1; kd 0.07) and with borrowings at domestic
(Russian) credit market (k0 0.18; kd 0.14). Here k0 is equity cost of financially
independent company (Fig. 15.5). The growing of effectiveness of investment when
using cheaper foreign credit is obvious. In case of the stabilization of the situation
at the external credit market, a detailed analysis of this case as well as of the case of
the use of domestic and overseas credits simultaneously can be done.
We analyze now the impact of the tax on profit rate on dependence of NPV on
leverage level at typical values of credit rates with borrowings abroad and with
borrowings at domestic (Russian) credit market (Fig. 15.6).
15.4 Dependence of NPV on Tax on Profit Rate at Different Leverage Levels 267
It is clear that at low leverage levels, the influence of tax on profit rate is very
significant: at zero leverage, the NPV drops by 80 units at increase of tax on profit
rate of 1 % when one borrows abroad and by 44 units when one borrows at domestic
(Russian) credit market. It would seem that this could be one of the signals for
borrowing within the country; however, taking into account the different values of
NPV at two considering cases (ratio is 2.1), we come to the conclusion that the
impact of tax on profit rate is in close proportions (ratio is 80/44 1.8). So it seems
that after the West sanctions will be over, to borrow at the West will be more
advantageous for a long time.
15.4 Dependence of NPV on Tax on Profit Rate at Different

Leverage Levels
From Fig. 15.7, it is seen that dependence of NPV on tax on profit rate significantly
depends on the leverage level L.
When there is no borrowing (L 0), NPV linearly decreases with t with a
factor 43.44 units at 1 %. When L 1, this factor (at t 20 %) is equal to 27.7
units at 1 %; when L 3, this factor (when t 20 %) is equal to 12.3 units at
1 %; and when L 5, this factor (at t 20 %) is equal to 5.8 units at 1 %. It
can be seen that the influence of tax on profit rate on efficiency of investment
projects drops significantly with increase of the leverage level L, used in
investments.
This is particularly seen in Fig. 15.8 in the dependence of NPV on tax on profit
rate at different leverage levels L (here NPV is increment of NPV under change of
t for 10 %). When there is no borrowing (L 0), NPV 450 and does not
depend on tax on profit rate. At t 20 %: at L 1 NPV 276.6; at L 3
NPV 122.6; at L 5 NPV 49. It is clear that the change of tax on profit
Fig. 15.7 Dependence of NPV(t)

NPV on tax on profit rate at 4000.00
1
different leverage levels
L (1L 0; 2L 1; 3 3000.00
L 3; 4L 5), 2
2000.00 3
NOI 800, I 1,000
NPV
1000.00
4
0.00
0 0.2 0.4 0.6 0.8 1 1.2
-1000.00
-2000.00
t

1 NPV (t)
NPV on tax on profit rate 0.00
at different leverage levels 0 0.2 0.4 0.6 0.8 1 1.2
L (1L 5; 2L 3; 3 -100.002
L 1; 4L 0),
-200.00
NOI 800, I 1,000
NPV
3
-300.00
-400.00
-500.004
t
rate affects mostly the effectiveness of the projects, funded by equity capital only,
and if you use debt financing to finance the projects, the impact of the change of tax
on profit rate drops very substantially (up to ten times).
15.5 At a Constant Value of Equity Capital (S Const)
At a constant value of equity capital (S const), when investment growth is

associated with the increased borrowing only, the dependence of NPV on leverage
level is qualitatively different in nature, rather than in the case of a constant value of
invested capital I. Now, depending on the values of the coefficient NOI=I, NPV
can grow with leverage level. It should be noted that in this case (at large values of
the coefficient ) the optimal structure of invested capital, in which NPV is
maximized, could take place. NPV in this case is described by the following
expression:
S1 L1 t
NPV S1 L1 t : 15:6
k0 k0 kd Lt 1
It is seen from Fig. 15.9 that with the increase of the coefficient value, NPV and its
optimal (maximum) values grow.
It follows from Fig. 15.10 that with the increase of the leverage level, NPV
drops and either goes to the saturation (NPV 0) or becomes negative
(NPV < 0), and this means that there is an optimum (after NPV > 0 at small
leverage level L ).
In Figs. 15.11 and 15.12, the dependencies of NPV and NPV on tax on profit
rate at different leverage levels and at S 500, 0.8 are shown.
From Fig. 15.11, as well as from Fig. 15.9, it is seen that at fixed tax on profit
rate, NPV grows with leverage level. With the increasing of tax on profit rate, NPV
drops, and curves, corresponding to the different leverage level converge in one
15.5 At a Constant Value of Equity Capital (S Const) 269

three values of -coefficient 9000.00 1
(1 1.5; 2 1.2; 8000.00
3 0.8), S 500 7000.00
6000.00
2
NPV
5000.00
4000.00
3000.00
2000.00
1000.00
0.00
0 2 4 6 8 10 12
L

L at three values of -
2000.00
coefficient (1 1.5; 2 1
1.2; 3 0.8), 1500.00
S 500
2
NPV
1000.00
500.00
0.00
0 2 4 6 8 10 12
-500.00
L

different leverage levels 3500.00
1
L (1L 5; 2L 3; 3 3000.00
L 1; 4L 0), S 500, 2500.00
0.8 2
2000.00
NPV
1500.00
1000.00
3
500.00
0.00 4
-500.00 0 0.2 0.4 0.6 0.8 1 1.2
-1000.00
t
point at t 100 % and NPV S in accordance to Eq. (15.6). Change of NPV

with increasing of t also depends on the leverage level: with the growth of the
leverage level, it changes from constant (at L 0) and increasingly growing at
t > 3040 % and at L 1; 3; 5.

at different leverage levels 0 0.2 0.4 0.6 0.8 1 1.2
L (1L 0; 2L 1; 3 -200.00 1
L 3; 4L 5), S 500,
0.8 -400.00
2
NPV
-600.00
3
-800.00
-1000.00
t
15.6 Without Flow Separation
Let us consider the case without the division of credit and investment flows. In this
case, both flows are discounted at the same rate, as which, obviously, WACC can be
chosen. In perpetuity limit
(n ! 1), one has
NOI1 t kd D1 t
NPV S : 15:7
WACC
15.6.1 At a Constant Value of the Total Invested Capital

(I Const)
In case of a constant value of the total invested capital (I const), accounting

D IL=1 L, S I=1 L, we get (Fig. 15.13)

1 Lkd 1 t NOI1 t
NPV I 1 : 15:8
1L k0 1 Lt=1 L k0 1 Lt=1 L
It should be noted that in contrast to the case with the division of flows, described
above, in a situation without the division of flows, NPV is growing with leverage
level. It is seen that while NOI increases by 1.5 times, NPV increases by 1.68 times
(Fig. 15.14).
NPV rather quickly goes to the saturation; at L > 4 it varies weakly, and the
leverage level, at which the saturation of NPV(L ) takes place, practically does not
depend on NOI value (Fig. 15.15).
NPV falls down with growth of tax on profit rate at different leverage levels:
At L 0 at change of tax on profit rate of 1 %, NPV falls down on 1.74 %.
15.6 Without Flow Separation 271

1
two values of NOI (1 6000.00
NOI 1,200; 2 5000.00
NOI 800), I 1,000 4000.00
NPV
3000.00
2000.00
1000.00
0.00
0 2 4 6 8 10 12
L

L at two values of NOI (1 600.00
NOI 1,200; 2 500.00
NOI 800), I 1,000 400.00
NPV
300.00
200.00
100.00 2
0.00
0 2 4 6 8 10 12
L

different leverage levels
L (1L 5; 2L 3; 3 3000.00 1
L 1; 4L 0), 2000.00 2
NOI 800, I 1,000 3
NPV
1000.00
0.00 4
0 0.2 0.4 0.6 0.8 1 1.2
-1000.00
-2000.00
t

It is seen that with the rising of the tax on profit rate by 1 %, NPV drops the less
at the higher leverage level. This confirms the conclusion, made in the previous
section, that with the increase of the leverage level, a negative impact of the growth
of the tax on profit rate declines in a few times, allowing the regulator to establish
the differentiated tax on profit rates (as can be seen from Fig. 15.16, the founded
conclusions are true up to tax on profit rate values of 7080 %).
Fig. 15.16 Dependence of NPV (t)

at different leverage levels -200.00 0 0.2 0.4 0.6 0.8 1
L (1L 5; 2L 3; 3 -400.00 4
L 1; 4L 0),
-600.00
NOI 800, I 1,000
NPV
-800.00 3
-1000.00
-1200.00 2
-1400.00
-1600.00 1
t
15.6.2 At a Constant Value of Equity Capital (S Const)
NOI1 t kd D1 t
NPV S : 15:9
WACC
Substituting D LS, one gets

Lkd 1 t S1 L1 t
NPV S 1 : 15:10
k0 1 Lt=1 L k0 1 Lt=1 L
From Fig. 15.17, it follows that NPV grows linearly with leverage level and its
growth rate increases with growth of coefficient .
From Fig. 15.18, it follows that NPV practically does not depend on leverage
level L, and at decrease of -coefficient by 1.25 times (the transition from line 1 to
line 2), NPV is decreased by 1.28 times (practically so), and at decrease of -
coefficient by 1.5 times (the transition from line 2 to line 3), NPV is decreased by
1.59 times (practically so).
As in the case of constant value of investments (I const), at constant equity
capital value (S const), NPV falls down with growth of tax on profit rate t at
different leverage levels L.
Let us take a look at the region of changes of tax on profit rates from 0 % up to
60 %. In this region:
And so, with the increasing of the tax on profit rates at 1 %, NPV drops the less
for the higher leverage level. This correlates with the conclusion, made above and
in the previous section, that with the increase of the leverage level, a negative
15.6 Without Flow Separation 273

three values of -coefficient 1
40000.00
(1 1.5; 2 1.2;
3 0.8), S 500 30000.00 2
NPV
20000.00
10000.00
0.00
0 2 4 6 8 10 12
L
Fig. 15.18 Dependence of DNPV(L)

L at three values of - 3500.00
1
coefficient (1 1.5; 2 3000.00
1.2; 3 0.8), 2500.00
2
S 500
DNPV
2000.00
1500.00
3
1000.00
500.00
0.00
0 2 4 6 8 10 12
L

NPV on tax on profit rate 12000.00 1
t at different leverage levels
10000.00
L (1L 5; 2L 3; 3
L 1; 4L 0), S 500 8000.00 2
6000.00
NPV
4000.00
3
2000.00
4
0.00
0 0.2 0.4 0.6 0.8 1 1.2
-2000.00
t
impact of the growth of the tax on profit rate declines in a few times, allowing the
regulator to introduce differentiated tax on profit rate (as it can be seen from
Figs. 15.19 and 15.20, the findings are true up to values of tax on profit rates
60 %). At higher rates (which, however, is a purely theoretical interest), the
situation will be different.

t at different leverage levels 1
0 0.2 0.4 0.6 0.8 1 1.2
L (1L 0; 2L 1; 3 -1000.00
2
L 3; 4L 5), S 500
-2000.00
NPV
3
-3000.00
-4000.00
-5000.00
t
Conclusions Within investment models, developed by Brusov, Filatova, and

Orekhova earlier (Brusov and Filatova 2011; Brusov et al. 2011a, b, c, 2012a, b,
2013a, b, 2014a, b; Filatova et al. 2008), the influence of tax on profit rate on
effectiveness of long-term investment projects at different debt levels is investi-
gated. The ability to obtain quantitative estimates of such impact on the projects
with various costs of equity and debt capital at an arbitrary structure of invested
capital has been demonstrated. It is shown that increase of tax on profit rate from
one side leads to decrease of project NPV, but from other side, it leads to decrease
of sensitivity of NPV with respect to leverage level. At high leverage level L, the
influence of tax on profit rate increase on effectiveness of investment projects
becomes significantly less. We come to conclusion that taxing could be differenti-
ated depending on debt level of investment projects of the company: for projects
with high debt level L, it is possible to apply a higher tax on profit rate.
These recommendations, in particular, may be addressed to the regulator. Effects
of taxation on the effectiveness of investment projects depend on the level of
leverage, on the project duration, on the equity cost, as well as on the level of
returns on investment (NOI) and on methods of forming of invested capital. The
study of all these problems, as the results of this chapter show, may be successfully
carried out within investment models developed by Brusov, Filatova, Orekhova,
using discount rates, derived from the BrusovFilatovaOrekhova (BFO) theory.
References
(11):815824
References 275

doi:10.1080/23322039.2014.946150
Econ Rev 53:147175
19541957. Am Econ Rev 56:333391
Chapter 16
Is It Possible to Increase the Investment
Efficiency by Increasing Tax on Profit Rate?
An Abnormal Influence of the Growth of Tax
on Profit Rate on the Efficiency
of the Investment
Within the modern theory of capital cost and capital structure by BrusovFilatova
Orekhova (BFO theory) (Brusov and Filatova 2011; Brusov et al. 2011a, b, c,
2012a, b, 2013a, b, 2014a, b; Filatova et al. 2008; Brusova 2011) and modern
investment models created within this theory, the influence of the growth of tax on
profit rate on the efficiency of the investment is investigated. It has been shown that
for long-term investment projects, as well as for arbitrary duration projects, the
growth of tax on profit rate changes the nature of the NPV dependence on leverage
at some value t*: there is a transition from the diminishing function NPV(L ), when
t < t*, to the growing function NPV(L). The t* value depends on the duration of the
project, cost of capital (equity and debt) values, and other parameters of the project.
At high leverage levels, this leads to a qualitatively new effect in investments:
growth of the efficiency of the investments with the growth of tax on profit rate.
Discovered effects take place under consideration from the point of view of owners
of equity capital as well as from the point of view of owners of equity and debt
capital.
16.1 Dependence of NPV on Leverage Level L at Fixed

Levels of Tax on Profit Rate t

Investigations will be done with the division of credit and investment flows;
operating and finance flows are divided and discounted using different rates:
operating flows, by the rate, equal to equity cost ke, depending on leverage, and
credit ones, by the rate, equal to debt cost kd, which, until a sufficiently large values
of leverage levels, remains constant and starts to grow only at sufficiently high

DOI 10.1007/978-3-319-14732-1_16
278 16 Is It Possible to Increase the Investment Efficiency by Increasing Tax on. . .
leverage values L, when a risk of bankruptcy will appear. The consideration has
been done upon constant value of investment capital I.
In this case NPV is described by the following formula (Brusov and Filatova
Brusova 2011):

I 1 1
NPV 1 L 1 t 1 n
1L 1 kd 1 k d n
16:1
NOI1 t 1
1 n :
ke 1 k e
Using it, we calculate NPV and NPV at fixed levels of tax on profit rate t.
5-Year Project
For 5-year projects, we get the following results (Tables 16.1, 16.2, 16.3, 16.4, 16.5,
16.6, and 16.7; Figs. 16.1 and 16.2).
Table 16.1 Dependence of NPV and NPV on leverage level L at fixed levels of tax on profit rate
t for a 5-year project at t 0.3
L k0 kd Wd t n NOI ke NPV NPV
0 0.18 0.14 0 0.3 5 800 0.18 751.22 4.922709
1 0.18 0.14 0.5 0.3 5 800 0.197488 756.14 36.8599
2 0.18 0.14 0.66667 0.3 5 800 0.214367 719.28 44.7663
3 0.18 0.14 0.75 0.3 5 800 0.231082 674.51 46.126
4 0.18 0.14 0.8 0.3 5 800 0.24773 628.39 45.4549
5 0.18 0.14 0.83333 0.3 5 800 0.264343 582.93 44.027
6 0.18 0.14 0.85714 0.3 5 800 0.280937 538.90 42.3084
7 0.18 0.14 0.875 0.3 5 800 0.297518 496.60 40.4978
8 0.18 0.14 0.88889 0.3 5 800 0.314091 456.10 38.6879
9 0.18 0.14 0.9 0.3 5 800 0.330658 417.41 36.9239
10 0.18 0.14 0.90909 0.3 5 800 0.34722 380.49
0 0.18 0.14 0 0.4 5 800 0.18 501.04 64.13345
1 0.18 0.14 0.5 0.4 5 800 0.189578 565.18 4.73089
2 0.18 0.14 0.66667 0.4 5 800 0.19803 569.91 9.5017
3 0.18 0.14 0.75 0.4 5 800 0.206172 560.40 14.7815
4 0.18 0.14 0.8 0.4 5 800 0.214184 545.62 17.1025
5 0.18 0.14 0.83333 0.4 5 800 0.22213 528.52 18.1709
6 0.18 0.14 0.85714 0.4 5 800 0.230037 510.35 18.6246
7 0.18 0.14 0.875 0.4 5 800 0.23792 491.73 18.7461
8 0.18 0.14 0.88889 0.4 5 800 0.245786 472.98 18.6762
9 0.18 0.14 0.9 0.4 5 800 0.253642 454.30 18.4911
10 0.18 0.14 0.90909 0.4 5 800 0.261488 435.81
16.1 Dependence of NPV on Leverage Level L at Fixed Levels of Tax on Profit Rate t 279
0 0.18 0.14 0 0.5 5 800 0.18 250.87 116.0669
1 0.18 0.14 0.5 0.5 5 800 0.181448 366.94 41.1323
2 0.18 0.14 0.66667 0.5 5 800 0.181065 408.07 22.57738
3 0.18 0.14 0.75 0.5 5 800 0.180162 430.65 15.19888
4 0.18 0.14 0.8 0.5 5 800 0.179041 445.84 11.52994
5 0.18 0.14 0.83333 0.5 5 800 0.177806 457.37 9.446706
6 0.18 0.14 0.85714 0.5 5 800 0.176505 466.82 8.154973
7 0.18 0.14 0.875 0.5 5 800 0.175162 474.98 7.302458
8 0.18 0.14 0.88889 0.5 5 800 0.173792 482.28 6.713275
9 0.18 0.14 0.9 0.5 5 800 0.172401 488.99 6.291579
10 0.18 0.14 0.90909 0.5 5 800 0.170996 495.28
0 0.18 0.14 0 0.6 5 800 0.18 0.69 160.0655
1 0.18 0.14 0.5 0.6 5 800 0.173086 160.76 70.95083
2 0.18 0.14 0.66667 0.6 5 800 0.163424 231.71 49.78654
3 0.18 0.14 0.75 0.6 5 800 0.15296 281.50 42.12961
4 0.18 0.14 0.8 0.6 5 800 0.142153 323.63 39.00243
5 0.18 0.14 0.83333 0.6 5 800 0.131168 362.63 37.85743
6 0.18 0.14 0.85714 0.6 5 800 0.120078 400.49 37.74625
7 0.18 0.14 0.875 0.6 5 800 0.108922 438.23 38.25211
8 0.18 0.14 0.88889 0.6 5 800 0.097721 476.49 39.17065
9 0.18 0.14 0.9 0.6 5 800 0.086488 515.66 40.39427
10 0.18 0.14 0.90909 0.6 5 800 0.075231 556.05
0 0.18 0.14 0 0.7 5 800 0.18 249.48 195.3877
1 0.18 0.14 0.5 0.7 5 800 0.16448 54.09 92.40829
2 0.18 0.14 0.66667 0.7 5 800 0.145057 38.32 69.68464
3 0.18 0.14 0.75 0.7 5 800 0.124461 108.00 63.19622
4 0.18 0.14 0.8 0.7 5 800 0.103355 171.20 62.43475
5 0.18 0.14 0.83333 0.7 5 800 0.081982 233.63 64.46977
6 0.18 0.14 0.85714 0.7 5 800 0.060453 298.10 68.26526
7 0.18 0.14 0.875 0.7 5 800 0.038822 366.37 73.42597
8 0.18 0.14 0.88889 0.7 5 800 0.017124 439.79 79.82524
9 0.18 0.14 0.9 0.7 5 800 0.00462 519.62 87.47314
10 0.18 0.14 0.90909 0.7 5 800 0.0264 607.09
0 0.18 0.14 0 0.8 5 800 0.18 499.65 221.1945
1 0.18 0.14 0.5 0.8 5 800 0.155616 278.46 103.2179
2 0.18 0.14 0.66667 0.8 5 800 0.125907 175.24 78.69376
3 0.18 0.14 0.75 0.8 5 800 0.094544 96.55 73.65304
4 0.18 0.14 0.8 0.8 5 800 0.062454 22.89 76.11182
5 0.18 0.14 0.83333 0.8 5 800 0.029979 53.22 82.93806
6 0.18 0.14 0.85714 0.8 5 800 0.00272 136.16 93.28915
7 0.18 0.14 0.875 0.8 5 800 0.03557 229.45 107.1925
8 0.18 0.14 0.88889 0.8 5 800 0.06852 336.64 125.1636
9 0.18 0.14 0.9 0.8 5 800 0.10154 461.80 148.1245
10 0.18 0.14 0.90909 0.8 5 800 0.13462 609.93
0 0.18 0.14 0 0.9 5 800 0.18 749.83 236.5329
1 0.18 0.14 0.5 0.9 5 800 0.14648 513.29 100.4127
2 0.18 0.14 0.66667 0.9 5 800 0.105908 412.88 71.49601
3 0.18 0.14 0.75 0.9 5 800 0.063074 341.38 65.36206
4 0.18 0.14 0.8 0.9 5 800 0.019228 276.02 68.55205
5 0.18 0.14 0.83333 0.9 5 800 0.02516 207.47 77.93497
6 0.18 0.14 0.85714 0.9 5 800 0.06987 129.54 93.29474
7 0.18 0.14 0.875 0.9 5 800 0.11479 36.24 115.8841
8 0.18 0.14 0.88889 0.9 5 800 0.15985 79.64 148.3017
9 0.18 0.14 0.9 0.9 5 800 0.20501 227.94 194.9563
10 0.18 0.14 0.90909 0.9 5 800 0.25024 422.90

NPV on leverage level L at
fixed levels of tax on profit
rate t for a 5-year project
One can see from Fig. 16.1 that the nature of the NPV dependence on leverage at
t* 0.5 is changed: there is a transition from the diminishing function NPV(L )
when t < t* to the growing function NPV(L) at t > t*.

NPV on leverage level
L at fixed levels of tax on
profit rate t for a 5-year
project
10-Year Project
For 10-year projects, we get the following results (Tables 16.8, 16.9, 16.10, 16.11,
16.12, 16.13, and 16.14; Figs. 16.3 and 16.4).
0 0.18 0.14 0 0.3 10 800 0.18 1,516.69 51.935
1 0.18 0.14 0.5 0.3 10 800 0.19907 1,464.75 101.47
2 0.18 0.14 0.66667 0.3 10 800 0.217182 1,363.28 104.843
3 0.18 0.14 0.75 0.3 10 800 0.235022 1,258.44 100.263
4 0.18 0.14 0.8 0.3 10 800 0.252747 1,158.18 93.8156
5 0.18 0.14 0.83333 0.3 10 800 0.270413 1,064.36 87.1129
6 0.18 0.14 0.85714 0.3 10 800 0.288045 977.25 80.6768
7 0.18 0.14 0.875 0.3 10 800 0.305654 896.57 74.6812
8 0.18 0.14 0.88889 0.3 10 800 0.323249 821.89 69.1705
9 0.18 0.14 0.9 0.3 10 800 0.340834 752.72 64.1369
10 0.18 0.14 0.90909 0.3 10 800 0.358411 688.58
0 0.18 0.14 0 0.4 10 800 0.18 1,157.16 61.10029
1 0.18 0.14 0.5 0.4 10 800 0.191455 1,218.26 18.517
2 0.18 0.14 0.66667 0.4 10 800 0.201083 1,199.74 35.7995
3 0.18 0.14 0.75 0.4 10 800 0.210169 1,163.95 41.1321
4 0.18 0.14 0.8 0.4 10 800 0.21902 1,122.81 42.6427
5 0.18 0.14 0.83333 0.4 10 800 0.22775 1,080.17 42.6081
6 0.18 0.14 0.85714 0.4 10 800 0.236408 1,037.56 41.8669
7 0.18 0.14 0.875 0.4 10 800 0.24502 995.70 40.7844
8 0.18 0.14 0.88889 0.4 10 800 0.253602 954.91 39.5386
9 0.18 0.14 0.9 0.4 10 800 0.262161 915.37 38.2228
10 0.18 0.14 0.90909 0.4 10 800 0.270705 877.15
Table 16.10 Dependence of NPV and NPV on leverage level L at fixed levels of tax on profit
rate t for a 10-year project at t 0.5
0 0.18 0.14 0 0.5 10 800 0.18 797.63 44.2013
1 0.18 0.14 0.5 0.5 10 800 0.219687 753.43 104.707
2 0.18 0.14 0.66667 0.5 10 800 0.255351 648.73 103.671
3 0.18 0.14 0.75 0.5 10 800 0.290005 545.06 93.6005
4 0.18 0.14 0.8 0.5 10 800 0.32421 451.45 82.6797
5 0.18 0.14 0.83333 0.5 10 800 0.358168 368.78 72.7174
6 0.18 0.14 0.85714 0.5 10 800 0.391982 296.06 64.0269
7 0.18 0.14 0.875 0.5 10 800 0.425702 232.03 56.5734
8 0.18 0.14 0.88889 0.5 10 800 0.459362 175.46 50.1953
9 0.18 0.14 0.9 0.5 10 800 0.492979 125.26 44.7383
10 0.18 0.14 0.90909 0.5 10 800 0.526564 80.52
0 0.18 0.14 0 0.6 10 800 0.18 438.11 244.5668
1 0.18 0.14 0.5 0.6 10 800 0.175084 682.67 125.4304
2 0.18 0.14 0.66667 0.6 10 800 0.165407 808.10 101.3662
3 0.18 0.14 0.75 0.6 10 800 0.154162 909.47 95.93652
4 0.18 0.14 0.8 0.6 10 800 0.142206 1,005.41 97.02629
5 0.18 0.14 0.83333 0.6 10 800 0.129869 1,102.43 101.3309
6 0.18 0.14 0.85714 0.6 10 800 0.117304 1,203.76 107.7015
7 0.18 0.14 0.875 0.6 10 800 0.10459 1,311.47 115.7055
8 0.18 0.14 0.88889 0.6 10 800 0.091775 1,427.17 125.2046
9 0.18 0.14 0.9 0.6 10 800 0.078888 1,552.38 136.2059
10 0.18 0.14 0.90909 0.6 10 800 0.065947 1,688.58
0 0.18 0.14 0 0.7 10 800 0.18 78.58 310.4744
1 0.18 0.14 0.5 0.7 10 800 0.166255 389.06 177.1979
2 0.18 0.14 0.66667 0.7 10 800 0.145497 566.25 160.5402
3 0.18 0.14 0.75 0.7 10 800 0.122295 726.79 169.9063
4 0.18 0.14 0.8 0.7 10 800 0.097953 896.70 191.9196
5 0.18 0.14 0.83333 0.7 10 800 0.072986 1,088.62 224.1724
6 0.18 0.14 0.85714 0.7 10 800 0.04764 1,312.79 267.4019
7 0.18 0.14 0.875 0.7 10 800 0.022047 1,580.19 323.9861
8 0.18 0.14 0.88889 0.7 10 800 0.00372 1,904.18 397.7601
9 0.18 0.14 0.9 0.7 10 800 0.0296 2,301.94 494.3094
10 0.18 0.14 0.90909 0.7 10 800 0.05558 2,796.25
0 0.18 0.14 0 0.8 10 800 0.18 280.95 355.2633
1 0.18 0.14 0.5 0.8 10 800 0.156938 74.32 204.8466
2 0.18 0.14 0.66667 0.8 10 800 0.123925 279.16 198.4863
3 0.18 0.14 0.75 0.8 10 800 0.087223 477.65 232.7806
4 0.18 0.14 0.8 0.8 10 800 0.048741 710.43 297.8303
5 0.18 0.14 0.83333 0.8 10 800 0.009262 1,008.26 400.9259
6 0.18 0.14 0.85714 0.8 10 800 0.03083 1,409.19 560.3743
7 0.18 0.14 0.875 0.8 10 800 0.07133 1,969.56 809.4944
8 0.18 0.14 0.88889 0.8 10 800 0.11211 2,779.06 1,207.425
9 0.18 0.14 0.9 0.8 10 800 0.1531 3,986.48 1,861.112
10 0.18 0.14 0.90909 0.8 10 800 0.19424 5,847.59
0 0.18 0.14 0 0.9 10 800 0.18 640.47 375.0978
1 0.18 0.14 0.5 0.9 10 800 0.147081 265.38 194.2145
2 0.18 0.14 0.66667 0.9 10 800 0.100417 71.16 186.9461
3 0.18 0.14 0.75 0.9 10 800 0.048303 115.79 239.586
4 0.18 0.14 0.8 0.9 10 800 0.00655 355.37 356.4744
5 0.18 0.14 0.83333 0.9 10 800 0.06297 711.85 583.6021
6 0.18 0.14 0.85714 0.9 10 800 0.12039 1,295.45 1,032.383
7 0.18 0.14 0.875 0.9 10 800 0.17847 2,327.83 1,967.211
8 0.18 0.14 0.88889 0.9 10 800 0.23701 4,295.04 4,054.338
9 0.18 0.14 0.9 0.9 10 800 0.2959 8,349.38 9,115.336
10 0.18 0.14 0.90909 0.9 10 800 0.35504 17,464.72


project
Perpetuity Limit
In perpetuity limit n ! 1 [odigliani and iller limit (odigliani and iller
1958, 1963, 1966)], the formula for NPV is as the following (Brusov and Filatova
2011; Brusov et al. 2011a, b, c, 2012a, b, 2013a, b, 2014a, b; Filatova et al. 2008):
NOI1 t
NPV S D1 t: 16:2
ke
At constant value of investment capital (I const), accounting D IL=1 L

and S I=1 L, one gets
I NOI1 t
NPV 1 L1 t : 16:3
1L ke
I NOI1 t
NPV 1 L1 t ; 16:4
1L k0 k0 kd L1 t
where L D=S is the leverage level; ke is the equity cost of a leverage company
(which uses the debt capital); and k0 is the equity cost of a financially independent
company.
In the transition from the Eq. (16.3) to Eq. (16.4), we have used the formula for
equity capital cost, received by odigliani and iller (1958, 1963, 1966):
ke k0 k0 kd L1 t: 16:5
For perpetuity projects, we get the following results (Tables 16.15, 16.16, 16.17,
16.18, 16.19, 16.20, and 16.21; Figs. 16.5 and 16.6).
rate t for a perpetuity project at t 0.3
L t k0 kd I NOI NPV NPV
0 0.3 0.18 0.14 1,000 800 2,111.111 268.803
1 0.3 0.18 0.14 1,000 800 1,842.308 269.426
2 0.3 0.18 0.14 1,000 800 1,572.881 226.669
3 0.3 0.18 0.14 1,000 800 1,346.212 188.404
4 0.3 0.18 0.14 1,000 800 1,157.808 157.808
5 0.3 0.18 0.14 1,000 800 1,000 133.662
6 0.3 0.18 0.14 1,000 800 866.3383 114.477
7 0.3 0.18 0.14 1,000 800 751.8617 99.0564
8 0.3 0.18 0.14 1,000 800 652.8053 86.509
9 0.3 0.18 0.14 1,000 800 566.2963 76.1777
10 0.3 0.18 0.14 1,000 800 490.1186
0 0.4 0.18 0.14 1,000 800 1,666.667 113.725
1 0.4 0.18 0.14 1,000 800 1,552.941 181.011
2 0.4 0.18 0.14 1,000 800 1,371.93 167.168
3 0.4 0.18 0.14 1,000 800 1,204.762 145.631
4 0.4 0.18 0.14 1,000 800 1,059.13 125.797
5 0.4 0.18 0.14 1,000 800 933.3333 108.995
6 0.4 0.18 0.14 1,000 800 824.3386 95.0283
7 0.4 0.18 0.14 1,000 800 729.3103 83.4322
8 0.4 0.18 0.14 1,000 800 645.8781 73.7569
9 0.4 0.18 0.14 1,000 800 572.1212 65.6277
10 0.4 0.18 0.14 1,000 800 506.4935
0 0.5 0.18 0.14 1,000 800 1,222.222 27.77778
1 0.5 0.18 0.14 1,000 800 1,250 98.4848
2 0.5 0.18 0.14 1,000 800 1,151.515 109.848
3 0.5 0.18 0.14 1,000 800 1,041.667 103.205
4 0.5 0.18 0.14 1,000 800 938.4615 93.2234
5 0.5 0.18 0.14 1,000 800 845.2381 83.3333
6 0.5 0.18 0.14 1,000 800 761.9048 74.4048
7 0.5 0.18 0.14 1,000 800 687.5 66.585
8 0.5 0.18 0.14 1,000 800 620.915 59.8039
9 0.5 0.18 0.14 1,000 800 561.1111 53.9341
10 0.5 0.18 0.14 1,000 800 507.177
0 0.6 0.18 0.14 1,000 800 777.7778 154.8753
1 0.6 0.18 0.14 1,000 800 932.6531 23.2191
2 0.6 0.18 0.14 1,000 800 909.434 55.9252
3 0.6 0.18 0.14 1,000 800 853.5088 62.0334
4 0.6 0.18 0.14 1,000 800 791.4754 60.7062
5 0.6 0.18 0.14 1,000 800 730.7692 57.0632
6 0.6 0.18 0.14 1,000 800 673.706 52.8156
7 0.6 0.18 0.14 1,000 800 620.8904 48.596
8 0.6 0.18 0.14 1,000 800 572.2944 44.6401
9 0.6 0.18 0.14 1,000 800 527.6543 41.0233
10 0.6 0.18 0.14 1,000 800 486.631
0 0.7 0.18 0.14 1,000 800 333.3333 266.6667
1 0.7 0.18 0.14 1,000 800 600 43.13725
2 0.7 0.18 0.14 1,000 800 643.1373 7.02614
3 0.7 0.18 0.14 1,000 800 636.1111 23.4795
4 0.7 0.18 0.14 1,000 800 612.6316 29.2982
5 0.7 0.18 0.14 1,000 800 583.3333 30.9524
6 0.7 0.18 0.14 1,000 800 552.381 30.79
7 0.7 0.18 0.14 1,000 800 521.5909 29.8035
8 0.7 0.18 0.14 1,000 800 491.7874 28.4541
9 0.7 0.18 0.14 1,000 800 463.3333 26.9697
10 0.7 0.18 0.14 1,000 800 436.3636
0 0.8 0.18 0.14 1,000 800 111.111 362.1749
1 0.8 0.18 0.14 1,000 800 251.0638 98.59603
2 0.8 0.18 0.14 1,000 800 349.6599 34.65386
3 0.8 0.18 0.14 1,000 800 384.3137 10.40326
4 0.8 0.18 0.14 1,000 800 394.717 0.77759
5 0.8 0.18 0.14 1,000 800 393.9394 6.47072
6 0.8 0.18 0.14 1,000 800 387.4687 9.50257
7 0.8 0.18 0.14 1,000 800 377.9661 11.1173
8 0.8 0.18 0.14 1,000 800 366.8488 11.9282
9 0.8 0.18 0.14 1,000 800 354.9206 12.2633
10 0.8 0.18 0.14 1,000 800 342.6573
0 0.9 0.18 0.14 1,000 800 555.556 440.3382
1 0.9 0.18 0.14 1,000 800 115.217 140.7493
2 0.9 0.18 0.14 1,000 800 25.53191 66.13475
3 0.9 0.18 0.14 1,000 800 91.66667 36.4966
4 0.9 0.18 0.14 1,000 800 128.1633 21.83673
5 0.9 0.18 0.14 1,000 800 150 13.58543
6 0.9 0.18 0.14 1,000 800 163.5854 8.52995
7 0.9 0.18 0.14 1,000 800 172.1154 5.243106
8 0.9 0.18 0.14 1,000 800 177.3585 3.01188
9 0.9 0.18 0.14 1,000 800 180.3704 1.447811
10 0.9 0.18 0.14 1,000 800 181.8182

rate t for a perpetuity project

profit rate t for a perpetuity
project

the Perspective of the Equity and Debt Holders
In this case we use the following expression for NPV (Brusov and Filatova 2011;
Brusov et al. 2011a, b, c, 2012a, b, 2013a, b, 2014a, b; Filatova et al. 2008):

Lt 1 NOI1 t 1
NPV I 1 1 1 16:6
1L 1 kd n ke 1 k e n
Using it, we calculate the dependence of NPV and NPV on leverage level L at
fixed levels of tax on profit rate t.
5-Year Project
16.26, 16.27, and 16.28; Figs. 16.7 and 16.8).
I L WACC k0 kd Wd t n NOI ke NPV NPV
1,000 0 0.18 0.18 0.14 0 0.3 5 800 0.18 751.2158 4.922709
1,000 1 0.14774 0.18 0.14 0.5 0.3 5 800 0.197488 756.1385 36.8599
1,000 2 0.13679 0.18 0.14 0.66667 0.3 5 800 0.214367 719.2786 44.7663
1,000 3 0.13127 0.18 0.14 0.75 0.3 5 800 0.231082 674.5122 46.126
1,000 4 0.12795 0.18 0.14 0.8 0.3 5 800 0.24773 628.3863 45.4549
1,000 5 0.12572 0.18 0.14 0.83333 0.3 5 800 0.264343 582.9313 44.027
1,000 6 0.12413 0.18 0.14 0.85714 0.3 5 800 0.280937 538.9044 42.3084
1,000 7 0.12294 0.18 0.14 0.875 0.3 5 800 0.297518 496.596 40.4978
1,000 8 0.12201 0.18 0.14 0.88889 0.3 5 800 0.314091 456.0982 38.6879
1,000 9 0.12127 0.18 0.14 0.9 0.3 5 800 0.330658 417.4103 36.9239
1,000 10 0.12066 0.18 0.14 0.90909 0.3 5 800 0.34722 380.4865
1,000 0 0.18 0.18 0.14 0 0.4 5 800 0.18 501.0421 64.13345
1,000 1 0.13679 0.18 0.14 0.5 0.4 5 800 0.189578 565.1755 4.73089
1,000 2 0.12201 0.18 0.14 0.66667 0.4 5 800 0.19803 569.9064 9.5017
1,000 3 0.11454 0.18 0.14 0.75 0.4 5 800 0.206172 560.4047 14.7815
1,000 4 0.11004 0.18 0.14 0.8 0.4 5 800 0.214184 545.6233 17.1025
1,000 5 0.10702 0.18 0.14 0.83333 0.4 5 800 0.22213 528.5208 18.1709
1,000 6 0.10486 0.18 0.14 0.85714 0.4 5 800 0.230037 510.3499 18.6246
1,000 7 0.10324 0.18 0.14 0.875 0.4 5 800 0.23792 491.7254 18.7461
1,000 8 0.10198 0.18 0.14 0.88889 0.4 5 800 0.245786 472.9793 18.6762
1,000 9 0.10096 0.18 0.14 0.9 0.4 5 800 0.253642 454.3031 18.4911
1,000 10 0.10014 0.18 0.14 0.90909 0.4 5 800 0.261488 435.812
1,000 0 0.18 0.18 0.14 0 0.5 5 800 0.18 250.8684 116.0669
1,000 1 0.12572 0.18 0.14 0.5 0.5 5 800 0.181448 366.9353 41.1323
1,000 2 0.10702 0.18 0.14 0.66667 0.5 5 800 0.181065 408.0676 22.57738
1,000 3 0.09754 0.18 0.14 0.75 0.5 5 800 0.180162 430.645 15.19888
1,000 4 0.09181 0.18 0.14 0.8 0.5 5 800 0.179041 445.8439 11.52994
1,000 5 0.08797 0.18 0.14 0.83333 0.5 5 800 0.177806 457.3738 9.446706
1,000 6 0.08522 0.18 0.14 0.85714 0.5 5 800 0.176505 466.8205 8.154973
1,000 7 0.08315 0.18 0.14 0.875 0.5 5 800 0.175162 474.9755 7.302458
1,000 8 0.08153 0.18 0.14 0.88889 0.5 5 800 0.173792 482.278 6.713275
1,000 9 0.08024 0.18 0.14 0.9 0.5 5 800 0.172401 488.9912 6.291579
1,000 10 0.07918 0.18 0.14 0.90909 0.5 5 800 0.170996 495.2828
1,000 0 0.18 0.18 0.14 0 0.6 5 800 0.18 0.694727 160.0655
1,000 1 0.11454 0.18 0.14 0.5 0.6 5 800 0.173086 160.7602 70.95083
1,000 2 0.09181 0.18 0.14 0.66667 0.6 5 800 0.163424 231.711 49.78654
1,000 3 0.08024 0.18 0.14 0.75 0.6 5 800 0.15296 281.4976 42.12961
1,000 4 0.07323 0.18 0.14 0.8 0.6 5 800 0.142153 323.6272 39.00243
1,000 5 0.06853 0.18 0.14 0.83333 0.6 5 800 0.131168 362.6296 37.85743
1,000 6 0.06515 0.18 0.14 0.85714 0.6 5 800 0.120078 400.487 37.74625
1,000 7 0.06262 0.18 0.14 0.875 0.6 5 800 0.108922 438.2333 38.25211
1,000 8 0.06064 0.18 0.14 0.88889 0.6 5 800 0.097721 476.4854 39.17065
1,000 9 0.05905 0.18 0.14 0.9 0.6 5 800 0.086488 515.656 40.39427
1,000 10 0.05775 0.18 0.14 0.90909 0.6 5 800 0.075231 556.0503
1,000 0 0.18 0.18 0.14 0 0.7 5 800 0.18 249.479 195.3877
1,000 1 0.10324 0.18 0.14 0.5 0.7 5 800 0.16448 54.0913 92.40829
1,000 2 0.07635 0.18 0.14 0.66667 0.7 5 800 0.145057 38.31702 69.68464
1,000 3 0.06262 0.18 0.14 0.75 0.7 5 800 0.124461 108.0017 63.19622
1,000 4 0.05427 0.18 0.14 0.8 0.7 5 800 0.103355 171.1979 62.43475
1,000 5 0.04866 0.18 0.14 0.83333 0.7 5 800 0.081982 233.6326 64.46977
1,000 6 0.04464 0.18 0.14 0.85714 0.7 5 800 0.060453 298.1024 68.26526
1,000 7 0.0416 0.18 0.14 0.875 0.7 5 800 0.038822 366.3677 73.42597
1,000 8 0.03924 0.18 0.14 0.88889 0.7 5 800 0.017124 439.7936 79.82524
1,000 9 0.03734 0.18 0.14 0.9 0.7 5 800 0.00462 519.6189 87.47314
1,000 10 0.03578 0.18 0.14 0.90909 0.7 5 800 0.0264 607.092
1,000 0 0.18 0.18 0.14 0 0.8 5 800 0.18 499.653 221.1945
1,000 1 0.09181 0.18 0.14 0.5 0.8 5 800 0.155616 278.458 103.2179
1,000 2 0.06064 0.18 0.14 0.66667 0.8 5 800 0.125907 175.24 78.69376
1,000 3 0.04464 0.18 0.14 0.75 0.8 5 800 0.094544 96.5465 73.65304
1,000 4 0.03489 0.18 0.14 0.8 0.8 5 800 0.062454 22.8934 76.11182
1,000 5 0.02833 0.18 0.14 0.83333 0.8 5 800 0.029979 53.21839 82.93806
1,000 6 0.02361 0.18 0.14 0.85714 0.8 5 800 0.00272 136.1565 93.28915
1,000 7 0.02005 0.18 0.14 0.875 0.8 5 800 0.03557 229.4456 107.1925
1,000 8 0.01728 0.18 0.14 0.88889 0.8 5 800 0.06852 336.6381 125.1636
1,000 9 0.01505 0.18 0.14 0.9 0.8 5 800 0.10154 461.8017 148.1245
1,000 10 0.01322 0.18 0.14 0.90909 0.8 5 800 0.13462 609.9262
1,000 0 0.18 0.18 0.14 0 0.9 5 800 0.18 749.826 236.5329
1,000 1 0.08024 0.18 0.14 0.5 0.9 5 800 0.14648 513.293 100.4127
1,000 2 0.04464 0.18 0.14 0.66667 0.9 5 800 0.105908 412.881 71.49601
1,000 3 0.02627 0.18 0.14 0.75 0.9 5 800 0.063074 341.385 65.36206
1,000 4 0.01505 0.18 0.14 0.8 0.9 5 800 0.019228 276.023 68.55205
1,000 5 0.00747 0.18 0.14 0.83333 0.9 5 800 0.02516 207.471 77.93497
1,000 6 0.00202 0.18 0.14 0.85714 0.9 5 800 0.06987 129.536 93.29474
1,000 7 0.0021 0.18 0.14 0.875 0.9 5 800 0.11479 36.2409 115.8841
1,000 8 0.0053 0.18 0.14 0.88889 0.9 5 800 0.15985 79.64322 148.3017
1,000 9 0.0079 0.18 0.14 0.9 0.9 5 800 0.20501 227.945 194.9563
1,000 10 0.01 0.18 0.14 0.90909 0.9 5 800 0.25024 422.9012


project
10-Year Project
For 10-year projects, we get the following results (Tables 16.29, 16.30, 16.31,
16.32, 16.33, 16.34, and 16.35; Figs. 16.9 and 16.10).
1,000 0 0.18 0.18 0.14 0 0.3 10 800 0.18 1,516.688 51.935
1,000 1 0.14854 0.18 0.14 0.5 0.3 10 800 0.19907 1,464.753 101.47
1,000 2 0.13773 0.18 0.14 0.66667 0.3 10 800 0.217182 1,363.283 104.843
1,000 3 0.13226 0.18 0.14 0.75 0.3 10 800 0.235022 1,258.441 100.263
1,000 4 0.12895 0.18 0.14 0.8 0.3 10 800 0.252747 1,158.178 93.8156
1,000 5 0.12674 0.18 0.14 0.83333 0.3 10 800 0.270413 1,064.362 87.1129
1,000 6 0.12515 0.18 0.14 0.85714 0.3 10 800 0.288045 977.2493 80.6768
1,000 7 0.12396 0.18 0.14 0.875 0.3 10 800 0.305654 896.5725 74.6812
1,000 8 0.12303 0.18 0.14 0.88889 0.3 10 800 0.323249 821.8913 69.1705
1,000 9 0.12228 0.18 0.14 0.9 0.3 10 800 0.340834 752.7207 64.1369
1,000 10 0.12167 0.18 0.14 0.90909 0.3 10 800 0.358411 688.5839
1,000 0 0.18 0.18 0.14 0 0.4 10 800 0.18 1,157.161 61.10029
1,000 1 0.13773 0.18 0.14 0.5 0.4 10 800 0.191455 1,218.262 18.517
1,000 2 0.12303 0.18 0.14 0.66667 0.4 10 800 0.201083 1,199.745 35.7995
1,000 3 0.11554 0.18 0.14 0.75 0.4 10 800 0.210169 1,163.945 41.1321
1,000 4 0.111 0.18 0.14 0.8 0.4 10 800 0.21902 1,122.813 42.6427
1,000 5 0.10796 0.18 0.14 0.83333 0.4 10 800 0.22775 1,080.17 42.6081
1,000 6 0.10577 0.18 0.14 0.85714 0.4 10 800 0.236408 1,037.562 41.8669
1,000 7 0.10413 0.18 0.14 0.875 0.4 10 800 0.24502 995.6955 40.7844
1,000 8 0.10284 0.18 0.14 0.88889 0.4 10 800 0.253602 954.9111 39.5386
1,000 9 0.10182 0.18 0.14 0.9 0.4 10 800 0.262161 915.3725 38.2228
1,000 10 0.10097 0.18 0.14 0.90909 0.4 10 800 0.270705 877.1497
1,000 0 0.18 0.18 0.14 0 0.5 10 800 0.18 797.6345 44.2013
1,000 1 0.14484 0.20056 0.14 0.5 0.5 10 800 0.219687 753.4333 104.707
1,000 2 0.13178 0.20836 0.14 0.66667 0.5 10 800 0.255351 648.7259 103.671
1,000 3 0.125 0.21253 0.14 0.75 0.5 10 800 0.290005 545.0552 93.6005
1,000 4 0.12084 0.21513 0.14 0.8 0.5 10 800 0.32421 451.4547 82.6797
1,000 5 0.11803 0.2169 0.14 0.83333 0.5 10 800 0.358168 368.775 72.7174
1,000 6 0.116 0.21819 0.14 0.85714 0.5 10 800 0.391982 296.0576 64.0269
1,000 7 0.11446 0.21917 0.14 0.875 0.5 10 800 0.425702 232.0307 56.5734
1,000 8 0.11326 0.21994 0.14 0.88889 0.5 10 800 0.459362 175.4573 50.1953
1,000 9 0.1123 0.22055 0.14 0.9 0.5 10 800 0.492979 125.262 44.7383
1,000 10 0.11151 0.22106 0.14 0.90909 0.5 10 800 0.526564 80.52365
1,000 0 0.18 0.18 0.14 0 0.6 10 800 0.18 438.1076 244.5668
1,000 1 0.11554 0.18 0.14 0.5 0.6 10 800 0.175084 682.6744 125.4304
1,000 2 0.09247 0.18 0.14 0.66667 0.6 10 800 0.165407 808.1048 101.3662
1,000 3 0.08054 0.18 0.14 0.75 0.6 10 800 0.154162 909.471 95.93652
1,000 4 0.07324 0.18 0.14 0.8 0.6 10 800 0.142206 1,005.408 97.02629
1,000 5 0.06831 0.18 0.14 0.83333 0.6 10 800 0.129869 1,102.434 101.3309
1,000 6 0.06476 0.18 0.14 0.85714 0.6 10 800 0.117304 1,203.765 107.7015
1,000 7 0.06207 0.18 0.14 0.875 0.6 10 800 0.10459 1,311.466 115.7055
1,000 8 0.05998 0.18 0.14 0.88889 0.6 10 800 0.091775 1,427.172 125.2046
1,000 9 0.05829 0.18 0.14 0.9 0.6 10 800 0.078888 1,552.376 136.2059
1,000 10 0.0569 0.18 0.14 0.90909 0.6 10 800 0.065947 1,688.582
1,000 0 0.18 0.18 0.14 0 0.7 10 800 0.18 78.58071 310.4744
1,000 1 0.10413 0.18 0.14 0.5 0.7 10 800 0.166255 389.0551 177.1979
1,000 2 0.0765 0.18 0.14 0.66667 0.7 10 800 0.145497 566.253 160.5402
1,000 3 0.06207 0.18 0.14 0.75 0.7 10 800 0.122295 726.7932 169.9063
1,000 4 0.05319 0.18 0.14 0.8 0.7 10 800 0.097953 896.6995 191.9196
1,000 5 0.04716 0.18 0.14 0.83333 0.7 10 800 0.072986 1,088.619 224.1724
1,000 6 0.04281 0.18 0.14 0.85714 0.7 10 800 0.04764 1,312.791 267.4019
1,000 7 0.03951 0.18 0.14 0.875 0.7 10 800 0.022047 1,580.193 323.9861
1,000 8 0.03692 0.18 0.14 0.88889 0.7 10 800 0.00372 1,904.18 397.7601
1,000 9 0.03484 0.18 0.14 0.9 0.7 10 800 0.0296 2,301.94 494.3094
1,000 10 0.03313 0.18 0.14 0.90909 0.7 10 800 0.05558 2,796.249
1,000 0 0.18 0.18 0.14 0 0.8 10 800 0.18 280.946 355.2633
1,000 1 0.09247 0.18 0.14 0.5 0.8 10 800 0.156938 74.31716 204.8466
1,000 2 0.05998 0.18 0.14 0.66667 0.8 10 800 0.123925 279.1638 198.4863
1,000 3 0.04281 0.18 0.14 0.75 0.8 10 800 0.087223 477.6501 232.7806
1,000 4 0.03215 0.18 0.14 0.8 0.8 10 800 0.048741 710.4306 297.8303
1,000 5 0.02488 0.18 0.14 0.83333 0.8 10 800 0.009262 1,008.261 400.9259
1,000 6 0.0196 0.18 0.14 0.85714 0.8 10 800 0.03083 1,409.187 560.3743
1,000 7 0.01558 0.18 0.14 0.875 0.8 10 800 0.07133 1,969.561 809.4944
1,000 8 0.01243 0.18 0.14 0.88889 0.8 10 800 0.11211 2,779.056 1,207.425
1,000 9 0.00989 0.18 0.14 0.9 0.8 10 800 0.1531 3,986.481 1,861.112
1,000 10 0.0078 0.18 0.14 0.90909 0.8 10 800 0.19424 5,847.593
1,000 0 0.18 0.18 0.14 0 0.9 10 800 0.18 640.473 375.0978
1,000 1 0.08054 0.18 0.14 0.5 0.9 10 800 0.147081 265.375 194.2145
1,000 2 0.04281 0.18 0.14 0.66667 0.9 10 800 0.100417 71.1609 186.9461
1,000 3 0.02258 0.18 0.14 0.75 0.9 10 800 0.048303 115.7852 239.586
1,000 4 0.00989 0.18 0.14 0.8 0.9 10 800 0.00655 355.3712 356.4744
1,000 5 0.00117 0.18 0.14 0.83333 0.9 10 800 0.06297 711.8456 583.6021
1,000 6 0.0052 0.18 0.14 0.85714 0.9 10 800 0.12039 1,295.448 1,032.383
1,000 7 0.0101 0.18 0.14 0.875 0.9 10 800 0.17847 2,327.831 1,967.211
1,000 8 0.0139 0.18 0.14 0.88889 0.9 10 800 0.23701 4,295.041 4,054.338
1,000 9 0.017 0.18 0.14 0.9 0.9 10 800 0.2959 8,349.379 9,115.336
1,000 10 0.0195 0.18 0.14 0.90909 0.9 10 800 0.35504 17,464.72


project
16.2 Dependence of NPV on Tax on Profit Rate at Fixed

Leverage Levels L
Below we study the dependence of NPV on tax on profit rate at fixed leverage
levels L.

5-Year Project
16.40, and 16.41; Figs. 16.11 and 16.12).
16.2 Dependence of NPV on Tax on Profit Rate at Fixed Leverage Levels L 295
Table 16.36 Dependence of NPV and NPV on tax on profit rate t at fixed leverage level L for a
5-year project at L 0
1,000 0 0.18 0.18 0.14 0 0 5 800 0.18 1,501.74 250.174
1,000 0 0.18 0.18 0.14 0 0.1 5 800 0.18 1,251.56 250.174
1,000 0 0.18 0.18 0.14 0 0.2 5 800 0.18 1,001.39 250.174
1,000 0 0.18 0.18 0.14 0 0.3 5 800 0.18 751.22 250.174
1,000 0 0.18 0.18 0.14 0 0.4 5 800 0.18 501.04 250.174
1,000 0 0.18 0.18 0.14 0 0.5 5 800 0.18 250.87 250.174
1,000 0 0.18 0.18 0.14 0 0.6 5 800 0.18 0.69 250.174
1,000 0 0.18 0.18 0.14 0 0.7 5 800 0.18 249.48 250.174
1,000 0 0.18 0.18 0.14 0 0.8 5 800 0.18 499.65 250.174
1,000 0 0.18 0.18 0.14 0 0.9 5 800 0.18 749.83 250.174
1,000 0 0.18 0.18 0.14 0 1 5 800 0.18 1,000.00
1,000 2 0.18 0.18 0.14 0.66667 0 5 800 0.26 1,108.06 120.983
1,000 2 0.16577 0.18 0.14 0.66667 0.1 5 800 0.245315 987.07 129.204
1,000 2 0.15137 0.18 0.14 0.66667 0.2 5 800 0.230116 857.87 138.59
1,000 2 0.13679 0.18 0.14 0.66667 0.3 5 800 0.214367 719.28 149.372
1,000 2 0.12201 0.18 0.14 0.66667 0.4 5 800 0.19803 569.91 161.839
1,000 2 0.10702 0.18 0.14 0.66667 0.5 5 800 0.181065 408.07 176.357
1,000 2 0.09181 0.18 0.14 0.66667 0.6 5 800 0.163424 231.71 193.394
1,000 2 0.07635 0.18 0.14 0.66667 0.7 5 800 0.145057 38.32 213.557
1,000 2 0.06064 0.18 0.14 0.66667 0.8 5 800 0.125907 175.24 237.64
1,000 2 0.04464 0.18 0.14 0.66667 0.9 5 800 0.105908 412.88 266.698
1,000 2 0.02833 0.18 0.14 0.66667 1 5 800 0.084989 679.58
1,000 4 0.18 0.18 0.14 0.8 0 5 800 0.34 808.33 51.044
1,000 4 0.16291 0.18 0.14 0.8 0.1 5 800 0.31053 757.29 59.2842
1,000 4 0.14556 0.18 0.14 0.8 0.2 5 800 0.279807 698.00 69.6148
1,000 4 0.12795 0.18 0.14 0.8 0.3 5 800 0.24773 628.39 82.763
1,000 4 0.11004 0.18 0.14 0.8 0.4 5 800 0.214184 545.62 99.7794
1,000 4 0.09181 0.18 0.14 0.8 0.5 5 800 0.179041 445.84 122.217
1,000 4 0.07323 0.18 0.14 0.8 0.6 5 800 0.142153 323.63 152.429
1,000 4 0.05427 0.18 0.14 0.8 0.7 5 800 0.103355 171.20 194.091
1,000 4 0.03489 0.18 0.14 0.8 0.8 5 800 0.062454 22.89 253.129
1,000 4 0.01505 0.18 0.14 0.8 0.9 5 800 0.019228 276.02 339.472
1,000 4 0.0053 0.18 0.14 0.8 1 5 800 0.02658 615.49
1,000 6 0.18 0.18 0.14 0.85714 0 5 800 0.42 574.85 6.23744
1,000 6 0.16168 0.18 0.14 0.85714 0.1 5 800 0.375729 568.61 11.31
1,000 6 0.14306 0.18 0.14 0.85714 0.2 5 800 0.329434 557.30 18.3975
1,000 6 0.12413 0.18 0.14 0.85714 0.3 5 800 0.280937 538.90 28.5544
1,000 6 0.10486 0.18 0.14 0.85714 0.4 5 800 0.230037 510.35 43.5294
1,000 6 0.08522 0.18 0.14 0.85714 0.5 5 800 0.176505 466.82 66.3335
1,000 6 0.06515 0.18 0.14 0.85714 0.6 5 800 0.120078 400.49 102.385
1,000 6 0.04464 0.18 0.14 0.85714 0.7 5 800 0.060453 298.10 161.946
1,000 6 0.02361 0.18 0.14 0.85714 0.8 5 800 0.00272 136.16 265.692
1,000 6 0.00202 0.18 0.14 0.85714 0.9 5 800 0.06987 129.54 458.495
1,000 6 0.0202 0.18 0.14 0.85714 1 5 800 0.14147 588.03
1,000 8 0.18 0.18 0.14 0.88889 0 5 800 0.5 389.30 23.47489
1,000 8 0.16099 0.18 0.14 0.88889 0.1 5 800 0.440923 412.78 22.6083
1,000 8 0.14167 0.18 0.14 0.88889 0.2 5 800 0.379039 435.38 20.71462
1,000 8 0.12201 0.18 0.14 0.88889 0.3 5 800 0.314091 456.10 16.88106
1,000 8 0.10198 0.18 0.14 0.88889 0.4 5 800 0.245786 472.98 9.298693
1,000 8 0.08153 0.18 0.14 0.88889 0.5 5 800 0.173792 482.28 5.79258
1,000 8 0.06064 0.18 0.14 0.88889 0.6 5 800 0.097721 476.49 36.6918
1,000 8 0.03924 0.18 0.14 0.88889 0.7 5 800 0.017124 439.79 103.156
1,000 8 0.01728 0.18 0.14 0.88889 0.8 5 800 0.06852 336.64 256.995
1,000 8 0.0053 0.18 0.14 0.88889 0.9 5 800 0.15985 79.64 652.415
1,000 8 0.0286 0.18 0.14 0.88889 1 5 800 0.25759 572.77
1,000 10 0.18 0.18 0.14 0.90909 0 5 800 0.58 239.23 43.49836

1,000 10 0.16056 0.18 0.14 0.90909 0.1 5 800 0.506115 282.73 46.87962
1,000 10 0.14078 0.18 0.14 0.90909 0.2 5 800 0.428635 329.61 50.87829
1,000 10 0.12066 0.18 0.14 0.90909 0.3 5 800 0.34722 380.49 55.32552
1,000 10 0.10014 0.18 0.14 0.90909 0.4 5 800 0.261488 435.81 59.47085
1,000 10 0.07918 0.18 0.14 0.90909 0.5 5 800 0.170996 495.28 60.76747
1,000 10 0.05775 0.18 0.14 0.90909 0.6 5 800 0.075231 556.05 51.04171
1,000 10 0.03578 0.18 0.14 0.90909 0.7 5 800 0.0264 607.09 2.834166
1,000 10 0.01322 0.18 0.14 0.90909 0.8 5 800 0.13462 609.93 187.024
1,000 10 0.01 0.18 0.14 0.90909 0.9 5 800 0.25024 422.90 985.964
1,000 10 0.034 0.18 0.14 0.90909 1 5 800 0.37429 563.06

NPV on tax on profit rate
t at fixed leverage level
L for a 5-year project

10-Year Project
16.45, 16.46, and 16.47; Figs. 16.13 and 16.14).
1,000 0 0.18 0.18 0.14 0 0 10 800 0.18 2,595.27 359.527
1,000 0 0.18 0.18 0.14 0 0.1 10 800 0.18 2,235.74 359.527
1,000 0 0.18 0.18 0.14 0 0.2 10 800 0.18 1,876.22 359.527
1,000 0 0.18 0.18 0.14 0 0.3 10 800 0.18 1,516.69 359.527
1,000 0 0.18 0.18 0.14 0 0.4 10 800 0.18 1,157.16 359.527
1,000 0 0.18 0.18 0.14 0 0.5 10 800 0.18 797.63 359.527
1,000 0 0.18 0.18 0.14 0 0.6 10 800 0.18 438.11 359.527
1,000 0 0.18 0.18 0.14 0 0.7 10 800 0.18 78.58 359.527
1,000 0 0.18 0.18 0.14 0 0.8 10 800 0.18 280.95 359.527
1,000 0 0.18 0.18 0.14 0 0.9 10 800 0.18 640.47 359.527
1,000 0 0.18 0.18 0.14 0 1 10 800 0.18 1,000.00
1,000 2 0.18 0.18 0.14 0.66667 0 10 800 0.26 1,771.84 125.137
1,000 2 0.16618 0.18 0.14 0.66667 0.1 10 800 0.24654 1,646.71 135.437
1,000 2 0.1521 0.18 0.14 0.66667 0.2 10 800 0.232299 1,511.27 147.987
1,000 2 0.13773 0.18 0.14 0.66667 0.3 10 800 0.217182 1,363.28 163.538
1,000 2 0.12303 0.18 0.14 0.66667 0.4 10 800 0.201083 1,199.74 183.17
1,000 2 0.10796 0.18 0.14 0.66667 0.5 10 800 0.183875 1,016.58 208.47
1,000 2 0.09247 0.18 0.14 0.66667 0.6 10 800 0.165407 808.10 241.852
1,000 2 0.0765 0.18 0.14 0.66667 0.7 10 800 0.145497 566.25 287.089
1,000 2 0.05998 0.18 0.14 0.66667 0.8 10 800 0.123925 279.16 350.325
1,000 2 0.04281 0.18 0.14 0.66667 0.9 10 800 0.100417 71.16 442.002
1,000 2 0.02488 0.18 0.14 0.66667 1 10 800 0.074631 513.16
1,000 4 0.18 0.18 0.14 0.8 0 10 800 0.34 1,226.89 475.625
1,000 4 0.18316 0.20056 0.14 0.8 0.1 10 800 0.411801 751.26 139.495
1,000 4 0.17256 0.20836 0.14 0.8 0.2 10 800 0.414791 611.77 74.4553
1,000 4 0.15772 0.21253 0.14 0.8 0.3 10 800 0.396579 537.31 54.8815
1,000 4 0.14072 0.21513 0.14 0.8 0.4 10 800 0.367589 482.43 52.0879
1,000 4 0.12227 0.2169 0.14 0.8 0.5 10 800 0.331331 430.34 60.1971
1,000 4 0.10261 0.21819 0.14 0.8 0.6 10 800 0.289071 370.14 80.4792
1,000 4 0.08181 0.21917 0.14 0.8 0.7 10 800 0.241069 289.66 120.753
1,000 4 0.0598 0.21994 0.14 0.8 0.8 10 800 0.186991 168.91 202.021
1,000 4 0.0364 0.22055 0.14 0.8 0.9 10 800 0.126013 33.11 382.685
1,000 4 0.01135 0.22106 0.14 0.8 1 10 800 0.056769 415.80
1,000 6 0.18 0.18 0.14 0.85714 0 10 800 0.42 847.62 37.06285
1,000 6 0.16218 0.18 0.14 0.85714 0.1 10 800 0.379295 884.68 42.53552
1,000 6 0.14392 0.18 0.14 0.85714 0.2 10 800 0.335473 927.22 50.03126
1,000 6 0.12515 0.18 0.14 0.85714 0.3 10 800 0.288045 977.25 60.31305
1,000 6 0.10577 0.18 0.14 0.85714 0.4 10 800 0.236408 1,037.56 74.23617
1,000 6 0.08569 0.18 0.14 0.85714 0.5 10 800 0.179813 1,111.80 91.96624
1,000 6 0.06476 0.18 0.14 0.85714 0.6 10 800 0.117304 1,203.76 109.0267
1,000 6 0.04281 0.18 0.14 0.85714 0.7 10 800 0.04764 1,312.79 96.39537
1,000 6 0.0196 0.18 0.14 0.85714 0.8 10 800 0.03083 1,409.19 113.739
1,000 6 0.0052 0.18 0.14 0.85714 0.9 10 800 0.12039 1,295.45 1,669.51
1,000 6 0.032 0.18 0.14 0.85714 1 10 800 0.22431 374.07
1,000 8 0.18 0.18 0.14 0.88889 0 10 800 0.5 572.25 67.74227

1,000 8 0.16152 0.18 0.14 0.88889 0.1 10 800 0.445653 640.00 80.91054
1,000 8 0.14255 0.18 0.14 0.88889 0.2 10 800 0.386973 720.91 100.9849
1,000 8 0.12303 0.18 0.14 0.88889 0.3 10 800 0.323249 821.89 133.0198
1,000 8 0.10284 0.18 0.14 0.88889 0.4 10 800 0.253602 954.91 187.1372
1,000 8 0.08188 0.18 0.14 0.88889 0.5 10 800 0.17692 1,142.05 285.1235
1,000 8 0.05998 0.18 0.14 0.88889 0.6 10 800 0.091775 1,427.17 477.0078
1,000 8 0.03692 0.18 0.14 0.88889 0.7 10 800 0.00372 1,904.18 874.876
1,000 8 0.01243 0.18 0.14 0.88889 0.8 10 800 0.11211 2,779.06 1,515.986
1,000 8 0.0139 0.18 0.14 0.88889 0.9 10 800 0.23701 4,295.04 4,645.92
1,000 8 0.0426 0.18 0.14 0.88889 1 10 800 0.38375 350.88
1,000 10 0.18 0.18 0.14 0.90909 0 10 800 0.58 365.08 85.01433

1,000 10 0.16109 0.18 0.14 0.90909 0.1 10 800 0.512008 450.10 103.8568
1,000 10 0.14168 0.18 0.14 0.90909 0.2 10 800 0.438456 553.96 134.6286
1,000 10 0.12167 0.18 0.14 0.90909 0.3 10 800 0.358411 688.58 188.5659
1,000 10 0.10097 0.18 0.14 0.90909 0.4 10 800 0.270705 877.15 292.3814
1,000 10 0.07944 0.18 0.14 0.90909 0.5 10 800 0.173857 1,169.53 519.0512
1,000 10 0.0569 0.18 0.14 0.90909 0.6 10 800 0.065947 1,688.58 1,107.667
1,000 10 0.03313 0.18 0.14 0.90909 0.7 10 800 0.05558 2,796.25 3,051.344
1,000 10 0.0078 0.18 0.14 0.90909 0.8 10 800 0.19424 5,847.59 11,617.12
1,000 10 0.0195 0.18 0.14 0.90909 0.9 10 800 0.35504 17,464.71 17,800.8
1,000 10 0.0496 0.18 0.14 0.90909 1 10 800 0.54557 336.13


Perpetuity Limit
For perpetuity projects, we get the following results (Tables 16.48 and 16.49;
Fig. 16.15).

L for a perpetuity project
perpetuity project at L 8
t L k0 kd I NOI NPV NPV
0 8 0.18 0.14 1,000 800 32,111.1 5,003.72
0.1 8 0.18 0.14 1,000 800 37,114.8 7,713.12
0.2 8 0.18 0.14 1,000 800 44,828 12,659.2
0.3 8 0.18 0.14 1,000 800 57,487.2 23,580
0.4 8 0.18 0.14 1,000 800 81,067.2 57,266.1
0.5 8 0.18 0.14 1,000 800 138,333 326,333
0.6 8 0.18 0.14 1,000 800 464,667 816,960.8
0.7 8 0.18 0.14 1,000 800 352,294.1 222,466
0.8 8 0.18 0.14 1,000 800 129,828.3 49,261
0.9 8 0.18 0.14 1,000 800 80,567.25 21,567.3
1 8 0.18 0.14 1,000 800 59,000
perpetuity project at L 10
t L k0 kd I NOI NPV NPV
0 10 0.18 0.14 1,000 800 41,000 9,090.91
0.1 10 0.18 0.14 1,000 800 50,090.9 15,909.1
0.2 10 0.18 0.14 1,000 800 66,000 32,692.3
0.3 10 0.18 0.14 1,000 800 98,692.3 99,450.5
0.4 10 0.18 0.14 1,000 800 198,143 8.6E+19
0.5 10 0.18 0.14 1,000 800 8.6E+19 8.65E+19
0.6 10 0.18 0.14 1,000 800 202,750 99,632.4
0.7 10 0.18 0.14 1,000 800 103,117.6 33,006.5
0.8 10 0.18 0.14 1,000 800 70,111.11 16,374.3
0.9 10 0.18 0.14 1,000 800 53,736.84 9,736.84
1 10 0.18 0.14 1,000 800 44,000

the Perspective of the Equity and Debt Holders
5-Year Project
16.54, and 16.55; Figs. 16.16 and 16.17).
1,000 0 0.18 0.18 0.14 0 0 5 800 0.18 1,501.737 250.174
1,000 0 0.18 0.18 0.14 0 0.1 5 800 0.18 1,251.563 250.174
1,000 0 0.18 0.18 0.14 0 0.2 5 800 0.18 1,001.389 250.174
1,000 0 0.18 0.18 0.14 0 0.3 5 800 0.18 751.2158 250.174
1,000 0 0.18 0.18 0.14 0 0.4 5 800 0.18 501.0421 250.174
1,000 0 0.18 0.18 0.14 0 0.5 5 800 0.18 250.8684 250.174
1,000 0 0.18 0.18 0.14 0 0.6 5 800 0.18 0.694727 250.174
1,000 0 0.18 0.18 0.14 0 0.7 5 800 0.18 249.479 250.174
1,000 0 0.18 0.18 0.14 0 0.8 5 800 0.18 499.653 250.174
1,000 0 0.18 0.18 0.14 0 0.9 5 800 0.18 749.826 250.174
1,000 0 0.18 0.18 0.14 0 1 5 800 0.18 1,000
1,000 2 0.18 0.18 0.14 0.66667 0 5 800 0.26 1,108.057 120.983
1,000 2 0.16577 0.18 0.14 0.66667 0.1 5 800 0.245315 987.0733 129.204
1,000 2 0.15137 0.18 0.14 0.66667 0.2 5 800 0.230116 857.869 138.59
1,000 2 0.13679 0.18 0.14 0.66667 0.3 5 800 0.214367 719.2786 149.372
1,000 2 0.12201 0.18 0.14 0.66667 0.4 5 800 0.19803 569.9064 161.839
1,000 2 0.10702 0.18 0.14 0.66667 0.5 5 800 0.181065 408.0676 176.357
1,000 2 0.09181 0.18 0.14 0.66667 0.6 5 800 0.163424 231.711 193.394
1,000 2 0.07635 0.18 0.14 0.66667 0.7 5 800 0.145057 38.31702 213.557
1,000 2 0.06064 0.18 0.14 0.66667 0.8 5 800 0.125907 175.24 237.64
1,000 2 0.04464 0.18 0.14 0.66667 0.9 5 800 0.105908 412.881 266.698
1,000 2 0.02833 0.18 0.14 0.66667 1 5 800 0.084989 679.579
1,000 4 0.18 0.18 0.14 0.8 0 5 800 0.34 808.3293 51.044
1,000 4 0.16291 0.18 0.14 0.8 0.1 5 800 0.31053 757.2853 59.2842
1,000 4 0.14556 0.18 0.14 0.8 0.2 5 800 0.279807 698.0011 69.6148
1,000 4 0.12795 0.18 0.14 0.8 0.3 5 800 0.24773 628.3863 82.763
1,000 4 0.11004 0.18 0.14 0.8 0.4 5 800 0.214184 545.6233 99.7794
1,000 4 0.09181 0.18 0.14 0.8 0.5 5 800 0.179041 445.8439 122.217
1,000 4 0.07323 0.18 0.14 0.8 0.6 5 800 0.142153 323.6272 152.429
1,000 4 0.05427 0.18 0.14 0.8 0.7 5 800 0.103355 171.1979 194.091
1,000 4 0.03489 0.18 0.14 0.8 0.8 5 800 0.062454 22.8934 253.129
1,000 4 0.01505 0.18 0.14 0.8 0.9 5 800 0.019228 276.023 339.472
1,000 4 0.0053 0.18 0.14 0.8 1 5 800 0.02658 615.495
1,000 6 0.18 0.18 0.14 0.85714 0 5 800 0.42 574.8492 6.23744

1,000 6 0.16168 0.18 0.14 0.85714 0.1 5 800 0.375729 568.6118 11.31
1,000 6 0.14306 0.18 0.14 0.85714 0.2 5 800 0.329434 557.3019 18.3975
1,000 6 0.12413 0.18 0.14 0.85714 0.3 5 800 0.280937 538.9044 28.5544
1,000 6 0.10486 0.18 0.14 0.85714 0.4 5 800 0.230037 510.3499 43.5294
1,000 6 0.08522 0.18 0.14 0.85714 0.5 5 800 0.176505 466.8205 66.3335
1,000 6 0.06515 0.18 0.14 0.85714 0.6 5 800 0.120078 400.487 102.385
1,000 6 0.04464 0.18 0.14 0.85714 0.7 5 800 0.060453 298.1024 161.946
1,000 6 0.02361 0.18 0.14 0.85714 0.8 5 800 0.00272 136.1565 265.692
1,000 6 0.00202 0.18 0.14 0.85714 0.9 5 800 0.06987 129.536 458.495
1,000 6 0.0202 0.18 0.14 0.85714 1 5 800 0.14147 588.03
1,000 8 0.18 0.18 0.14 0.88889 0 5 800 0.5 389.3004 23.47489

1,000 8 0.16099 0.18 0.14 0.88889 0.1 5 800 0.440923 412.7753 22.6083
1,000 8 0.14167 0.18 0.14 0.88889 0.2 5 800 0.379039 435.3836 20.71462
1,000 8 0.12201 0.18 0.14 0.88889 0.3 5 800 0.314091 456.0982 16.88106
1,000 8 0.10198 0.18 0.14 0.88889 0.4 5 800 0.245786 472.9793 9.298693
1,000 8 0.08153 0.18 0.14 0.88889 0.5 5 800 0.173792 482.278 5.79258
1,000 8 0.06064 0.18 0.14 0.88889 0.6 5 800 0.097721 476.4854 36.6918
1,000 8 0.03924 0.18 0.14 0.88889 0.7 5 800 0.017124 439.7936 103.156
1,000 8 0.01728 0.18 0.14 0.88889 0.8 5 800 0.06852 336.6381 256.995
1,000 8 0.0053 0.18 0.14 0.88889 0.9 5 800 0.15985 79.64322 652.415
1,000 8 0.0286 0.18 0.14 0.88889 1 5 800 0.25759 572.772
1,000 10 0.18 0.18 0.14 0.90909 0 5 800 0.58 239.2302 43.49836
1,000 10 0.16056 0.18 0.14 0.90909 0.1 5 800 0.506115 282.7286 46.87962
1,000 10 0.14078 0.18 0.14 0.90909 0.2 5 800 0.428635 329.6082 50.87829
1,000 10 0.12066 0.18 0.14 0.90909 0.3 5 800 0.34722 380.4865 55.32552
1,000 10 0.10014 0.18 0.14 0.90909 0.4 5 800 0.261488 435.812 59.47085
1,000 10 0.07918 0.18 0.14 0.90909 0.5 5 800 0.170996 495.2828 60.76747
1,000 10 0.05775 0.18 0.14 0.90909 0.6 5 800 0.075231 556.0503 51.04171
1,000 10 0.03578 0.18 0.14 0.90909 0.7 5 800 0.0264 607.092 2.834166
1,000 10 0.01322 0.18 0.14 0.90909 0.8 5 800 0.13462 609.9262 187.024
1,000 10 0.01 0.18 0.14 0.90909 0.9 5 800 0.25024 422.9017 985.964
1,000 10 0.034 0.18 0.14 0.90909 1 5 800 0.37429 563.062


10-Year Projects
16.59, 16.60, and 16.61; Figs. 16.18, 16.19, 16.20, and 16.21).
1,000 0 0.18 0.18 0.14 0 0 10 800 0.18 2,595.269 359.527
1,000 0 0.18 0.18 0.14 0 0.1 10 800 0.18 2,235.742 359.527
1,000 0 0.18 0.18 0.14 0 0.2 10 800 0.18 1,876.215 359.527
1,000 0 0.18 0.18 0.14 0 0.3 10 800 0.18 1,516.688 359.527
1,000 0 0.18 0.18 0.14 0 0.4 10 800 0.18 1,157.161 359.527
1,000 0 0.18 0.18 0.14 0 0.5 10 800 0.18 797.6345 359.527
1,000 0 0.18 0.18 0.14 0 0.6 10 800 0.18 438.1076 359.527
1,000 0 0.18 0.18 0.14 0 0.7 10 800 0.18 78.58071 359.527
1,000 0 0.18 0.18 0.14 0 0.8 10 800 0.18 280.946 359.527
1,000 0 0.18 0.18 0.14 0 0.9 10 800 0.18 640.473 359.527
1,000 0 0.18 0.18 0.14 0 1 10 800 0.18 1,000
1,000 2 0.18 0.18 0.14 0.66667 0 10 800 0.26 1,771.845 125.137
1,000 2 0.16618 0.18 0.14 0.66667 0.1 10 800 0.24654 1,646.708 135.437
1,000 2 0.1521 0.18 0.14 0.66667 0.2 10 800 0.232299 1,511.27 147.987
1,000 2 0.13773 0.18 0.14 0.66667 0.3 10 800 0.217182 1,363.283 163.538
1,000 2 0.12303 0.18 0.14 0.66667 0.4 10 800 0.201083 1,199.745 183.17
1,000 2 0.10796 0.18 0.14 0.66667 0.5 10 800 0.183875 1,016.575 208.47
1,000 2 0.09247 0.18 0.14 0.66667 0.6 10 800 0.165407 808.1048 241.852
1,000 2 0.0765 0.18 0.14 0.66667 0.7 10 800 0.145497 566.253 287.089
1,000 2 0.05998 0.18 0.14 0.66667 0.8 10 800 0.123925 279.1638 350.325
1,000 2 0.04281 0.18 0.14 0.66667 0.9 10 800 0.100417 71.1609 442.002
1,000 2 0.02488 0.18 0.14 0.66667 1 10 800 0.074631 513.163
1,000 4 0.18 0.18 0.14 0.8 0 10 800 0.34 1,226.885 475.625
1,000 4 0.18316 0.20056 0.14 0.8 0.1 10 800 0.411801 751.2601 139.495
1,000 4 0.17256 0.20836 0.14 0.8 0.2 10 800 0.414791 611.7654 74.4553
1,000 4 0.15772 0.21253 0.14 0.8 0.3 10 800 0.396579 537.3101 54.8815
1,000 4 0.14072 0.21513 0.14 0.8 0.4 10 800 0.367589 482.4286 52.0879
1,000 4 0.12227 0.2169 0.14 0.8 0.5 10 800 0.331331 430.3407 60.1971
1,000 4 0.10261 0.21819 0.14 0.8 0.6 10 800 0.289071 370.1436 80.4792
1,000 4 0.08181 0.21917 0.14 0.8 0.7 10 800 0.241069 289.6644 120.753
1,000 4 0.0598 0.21994 0.14 0.8 0.8 10 800 0.186991 168.9112 202.021
1,000 4 0.0364 0.22055 0.14 0.8 0.9 10 800 0.126013 33.1095 382.685
1,000 4 0.01135 0.22106 0.14 0.8 1 10 800 0.056769 415.795
1,000 6 0.18 0.18 0.14 0.85714 0 10 800 0.42 847.6197 37.06285
1,000 6 0.16218 0.18 0.14 0.85714 0.1 10 800 0.379295 884.6825 42.53552
1,000 6 0.14392 0.18 0.14 0.85714 0.2 10 800 0.335473 927.218 50.03126
1,000 6 0.12515 0.18 0.14 0.85714 0.3 10 800 0.288045 977.2493 60.31305
1,000 6 0.10577 0.18 0.14 0.85714 0.4 10 800 0.236408 1,037.562 74.23617
1,000 6 0.08569 0.18 0.14 0.85714 0.5 10 800 0.179813 1,111.799 91.96624
1,000 6 0.06476 0.18 0.14 0.85714 0.6 10 800 0.117304 1,203.765 109.0267
1,000 6 0.04281 0.18 0.14 0.85714 0.7 10 800 0.04764 1,312.791 96.39537
1,000 6 0.0196 0.18 0.14 0.85714 0.8 10 800 0.03083 1,409.187 113.739
1,000 6 0.0052 0.18 0.14 0.85714 0.9 10 800 0.12039 1,295.448 1,669.51
1,000 6 0.032 0.18 0.14 0.85714 1 10 800 0.22431 374.066
1,000 8 0.18 0.18 0.14 0.88889 0 10 800 0.5 572.2536 67.74227

1,000 8 0.16152 0.18 0.14 0.88889 0.1 10 800 0.445653 639.9958 80.91054
1,000 8 0.14255 0.18 0.14 0.88889 0.2 10 800 0.386973 720.9064 100.9849
1,000 8 0.12303 0.18 0.14 0.88889 0.3 10 800 0.323249 821.8913 133.0198
1,000 8 0.10284 0.18 0.14 0.88889 0.4 10 800 0.253602 954.9111 187.1372
1,000 8 0.08188 0.18 0.14 0.88889 0.5 10 800 0.17692 1,142.048 285.1235
1,000 8 0.05998 0.18 0.14 0.88889 0.6 10 800 0.091775 1,427.172 477.0078
1,000 8 0.03692 0.18 0.14 0.88889 0.7 10 800 0.00372 1,904.18 874.876
1,000 8 0.01243 0.18 0.14 0.88889 0.8 10 800 0.11211 2,779.056 1,515.986
1,000 8 0.0139 0.18 0.14 0.88889 0.9 10 800 0.23701 4,295.041 4,645.92
1,000 8 0.0426 0.18 0.14 0.88889 1 10 800 0.38375 350.883
1,000 10 0.18 0.18 0.14 0.90909 0 10 800 0.58 365.0841 85.01433

1,000 10 0.16109 0.18 0.14 0.90909 0.1 10 800 0.512008 450.0984 103.8568
1,000 10 0.14168 0.18 0.14 0.90909 0.2 10 800 0.438456 553.9552 134.6286
1,000 10 0.12167 0.18 0.14 0.90909 0.3 10 800 0.358411 688.5839 188.5659
1,000 10 0.10097 0.18 0.14 0.90909 0.4 10 800 0.270705 877.1497 292.3814
1,000 10 0.07944 0.18 0.14 0.90909 0.5 10 800 0.173857 1,169.531 519.0512
1,000 10 0.0569 0.18 0.14 0.90909 0.6 10 800 0.065947 1,688.582 1,107.667
1,000 10 0.03313 0.18 0.14 0.90909 0.7 10 800 0.05558 2,796.249 3,051.344
1,000 10 0.0078 0.18 0.14 0.90909 0.8 10 800 0.19424 5,847.593 11,617.12
1,000 10 0.0195 0.18 0.14 0.90909 0.9 10 800 0.35504 17,464.71 17,800.8
1,000 10 0.0496 0.18 0.14 0.90909 1 10 800 0.54557 336.131

Or more detailed

(more detailed)
It is seen from Fig. 16.19 that falling trend at L 0, 2, and 4 alternates by

growing trend at higher leverage levels L 6, 8, and 10.
The observed increase of NPV at high leverage levels (starting from L 6) with
growth of tax on profit rate t takes place at all values of t, which means that this is an
entirely new effect in investments, which can be applied in a real economic practice
for the optimization of the management of investments.

Let us consider more detailed figure.

(more detailed)
Conclusions Within the modern theory of capital cost and capital structure by
BrusovFilatovaOrekhova (BFO theory) and modern investment models created
within this theory, the influence of the growth of tax on profit rate on the efficiency
of the investment is investigated. It has been shown that for arbitrary duration
projects as well as for perpetuity projects, the growth of tax on profit rate changes
the nature of the NPV dependence on leverage at some value t*: there is a transition
from the diminishing function NPV(L) when t < t* to the growing function NPV(L)
at t > t*. The t* value depends on the duration of the project, cost of capital (equity
and debt) values, and other parameters of the project.
At high leverage levels, this leads to a qualitatively new effect in invest-
ments: growth of the efficiency of the investments with the growth of tax on
profit rate. Discovered effects take place under consideration from the point of
view of owners of equity capital as well as from the point of view of owners of
equity and debt capital.
The observed increase of NPV at high leverage levels (starting from L 6) with
growth of tax on profit rate t takes place at all values of t, which means that this is an
entirely new effect in investments which can be applied in a real economic practice
for the optimization of the management of investments.
So, two very important qualitatively new effects in investments have been
discovered:
1. Change of the character of NPV dependence on leverage with growth of tax on

profit rate
2. Growth of the efficiency of the investments with growth of tax on profit rate
Both effects could be used in practice to optimize the investments.
References
(11):815824
doi:10.1080/23322039.2014.946150
Econ Rev 53:147175
19541957. Am Econ Rev 56:333391
Chapter 17
Optimizing the Investment Structure
of the Telecommunication Sector Company
In this chapter developed by the authors models on the evaluation of the depen-
dence of the effectiveness of investments on debt financing are applied for the
analysis of investments of one of the telecommunication company for 20102012
from the point of view of optimal structure of investment. The analysis revealed
that only in 2011, the companys investment structure was close to the optimal.
Introduction Investments in tangible and intangible assets play an important role
in the activities of any company. They are a necessary condition for structural
adjustment and economic growth and provide the creation of new and enhancement
of existing basic funds and industries. The role of investment, which is always the
one of the most important, is increased many times at the current stage.
For example, in Russia a priority of budget will be the reduced of dependence of
the price of oil and gas. The main issue that helps at least to start the movement on
this way is, of course, investments. In this way, the role of investment at the present
stage is indeed increasing dramatically. In this regard, the role of the evaluation of
the efficiency of investment projects, which in the context of scarcity and limited
investment resources allows the realization of the most effective projects, increases.
Since virtually all investment projects use debt financing, the purpose of the study
of the impact of debt financing and capital structure on the efficiency of investment
projects, determining the optimal level leverage, is especially actual at the
present time.
The hope to determine the optimal capital structure, in which one or more
parameters of the efficiency of the project (NPV, IRR, etc.) are maximum, more
than half a century has encouraged researchers to deal with the issue. Some of the
major problems in the assessment of the effectiveness of the projects are the
following:
What are financial flows and why are they necessary to take into account when
calculating parameters of efficiency of the project (NPV, IRR, etc.)?

DOI 10.1007/978-3-319-14732-1_17
310 17 Optimizing the Investment Structure of the Telecommunication Sector Company
How many discount rate should be used for financial flows associated with
investments?
How can these discount rates be accurately determined?
Discussion concerning the first two problems is ongoing. On the third issue, one
needs to note that, in recent years, there has been a significant progress in the
accurate determination of the cost of the equity capital of the company and its
weighted average cost, which as time and are the discount rate when evaluating the
NPV of the project. The progress is associated with work performed by Brusov,
Filatova, and Orekhova (Brusov and Filatova 2011; Brusov et al. 2011a, b, c, 2012a,
b, 2013a, b, 2014a, b; Filatova et al. 2008; Brusova 2011), in which the general
theory of capital cost of the company (equity cost as well as weighted average cost)
was established and its dependence on leverage and on lifetime (age) of company
was found for the companies with arbitrary lifetime (age). The main difference
between their theory and theory by Modigliani and Miller is that the former one
waives from the perpetuity of the companies, which leads to significant differences
of a new theory from theory of Nobel laureates Modigliani and Miller (1958, 1963,
1966).
The lack of modern methods of evaluation of effectiveness of investment pro-
jects with account of the debt financing, with the correct assessment of discount
rate, used in investment models, has identified the need for research. The establish-
ment of such modern models, considering problem from the point of view of equity
capital owners as well as from the point of view of equity and debt capital owners,
with the use of modern theory by Brusov, Filatova, and Orekhova that assesses the
equity capital cost and weighted average cost of capital of the company (odigliani
and iller 1958, 1963, 1966), which play the role of discount rate in the investment
models, can significantly contribute to the problem of the assessment of investment
projects effectiveness.
17.1 Investment Analysis and Recommendations

for Telecommunication Company Nastcom Plus
Based on the method, developed by the authors (Brusov and Filatova 2011; Brusov
et al. 2011a, b, c, 2012a, b, 2013a, b, 2014a, b; Filatova et al. 2008), let us analyze
the efficiency of investments of one of the leading companies in the telecommuni-
cation sector Nastcom Plus for 20102012 from the point of view of optimal
structure of investment. The source data for the analysis are presented in Table 17.1.
Quantity k0 is the equity cost of financially independent company (or equity cost
at zero leverage) and for Nastcom Plus is equal to 23.67 % (Brusova 2011). Here
are also calculated dependence of weighted average cost of capital WACC and the
equity cost ke on leverage (Fig. 17.1).
17.1 Investment Analysis and Recommendations for Telecommunication Company. . . 311
Table 17.1 Data of Nastcom Plus for 20102012

Indicator 2010 2011 2012
Investment I, million dollars 1.124 2.05 2.763
Revenue, million dollars 7,204.335 8,232.172 9,418.773
Net operating income for the year before taxing, NOI, 2,161.3 2,469.174 2,826
million dollars
Equity cost at zero leverage, k0, % 23.67 23.67 23.67
Debt cost kd , % 8.26 7.4 6.69
Return on investment for 1 year, I/NOI 1.92 1.204 1.02
Amount of debt financing, % 35 50 50
Amount of equity, % 65 50 50
Leverage level, L 0.54 1 1
Amount of equity capital S, million dollars 730.6 1,025 1,381.5
K
60
ke
50 ke
40 4
5
6
30
ke
1 WACC
2
20 3 WACC
WACC
10
L
0 0.5 1 1.5 2 2.5 3
Fig. 17.1 Dependence of weighted average cost of capital WACC and the equity cost ke on
leverage: 1, 4 within BrusovFilatovaOrekhova theory; 2, 5 within ModiglianiMiller theory; 3,
6 within traditional approach
17.1.1 The Dependence of NPV on Investment Capital

Structure
Analysis of investment will be continued with use of the formula provided in the
works (Brusov and Filatova 2011; Brusov et al. 2011a, b, c, 2012a, b, 2013a, b,
2014a, b; Filatova et al. 2008):

1 1
NPV S 1 L 1 t 1 n n
1 k d 1 kd 17:1
S1 L1 t 1
1 ;
ke 1 k e n
Where: NPVnet present value

Sequity capital amount
Lleverage level
ttax on profit rate
kddebt cost
nproject duration
return on investment for 1 year
keequity cost
Analysis of Investments in 2010 Using companys data (Table 17.1), we compute
the WACC, ke, and NPV (Tables 17.2, 17.3, and 17.4; Figs. 17.1 and 17.2).
In the companys investment in 2010, equity capital accounted for 65 %, and
debt 35 %, i.e., the leverage level was equal to L 0.54. The term for hardware
depreciation, into establishment of which investment was done, was 5 years. Curve
2 (Fig. 17.2) corresponds to dependence of NPV on leverage level for the 5-year
project. Optimum NPV is achieved when L 2. At this leverage level,
NPV 3,624.5 million dollars.
The level leverage with which Nastcom Plus has carried out its investment
projects (L 0.54) was lying far from optimum and provided NPV 2,979.2
million dollars, which is approximately 645 million dollars less than the optimal
value of NPV.
Since the equipment can be operated, after depreciation, one can estimate the
NPV for a more long-term perspective. For example, for the 7-year project, the
optimal leverage value is L 2.0, when the NPV 4,157.6 million dollars, which is
562.8 million dollars more than nonoptimal values of NPV 3,594.8 million
dollars, obtained by the company. For the 10-year project, the optimal leverage
level is L 1.5, with NPV 4,509.1 million dollars, which is 422.9 million dollars
more than nonoptimal values of NPV 4,086.2 million dollars, obtained by the
company (Fig. 17.2; Tables 17.2, 17.3, and 17.4).
Analysis of Investments in 2011 Using companys data, we compute the WACC,
ke, and NPV (Tables 17.5, 17.6, and 17.7; Fig. 17.3).
In the companys investment in 2011, equity capital accounted for 50 %, and
debt capital for 50 % as well, i.e., the leverage level was equal to L 1. The term for
hardware depreciation, into establishment of which investment was done, was
5 years. Curve 2 (Fig. 17.3) corresponds to dependence of NPV on leverage level
17.1
Table 17.2 Weighted average cost of capital, WACC, in 2010

Leverage level L
Project duration n 0 0.5 1 1.5 2 2.5 3 3.5 4 4.5 5
2 0.2367 0.2284 0.2242 0.2217 0.2201 0.2189 0.2180 0.2173 0.2167 0.2163 0.2159
5 0.2367 0.2262 0.2209 0.2177 0.2156 0.2141 0.2130 0.2121 0.2114 0.2108 0.2103
7 0.2367 0.2256 0.2199 0.2166 0.2143 0.2127 0.2116 0.2106 0.2099 0.2093 0.2087
10 0.2366 0.2250 0.2190 0.2155 0.2131 0.2114 0.2101 0.2091 0.2083 0.2076 0.2071
Investment Analysis and Recommendations for Telecommunication Company. . .
313
314
17
Table 17.3 Equity cost, ke, in 2010

Leverage level L
2 0.2367 0.3096 0.3824 0.4552 0.5280 0.6008 0.6736 0.7464 0.8192 0.8920 0.9649
5 0.2367 0.3063 0.3758 0.4452 0.5147 0.5841 0.6536 0.7230 0.7925 0.8619 0.9314
7 0.2367 0.3053 0.3738 0.4423 0.5107 0.5791 0.6480 0.7165 0.7850 0.8535 0.9220
10 0.2366 0.3044 0.3720 0.4396 0.5071 0.5746 0.6422 0.7097 0.7772 0.8447 0.9122
Optimizing the Investment Structure of the Telecommunication Sector Company
17.1
Table 17.4 Net present value, NPV, in 2010 , million dollars

Leverage level L
2 910.5 1,181.8 1,358.3 1,458.5 1,496.3 1,482.8 1,426.6 1,334.6 1,212.4 1,064.5 894.5
5 2,371.6 2,979.2 3,347.7 3,547.1 3,624.5 3,612.4 3,533.6 3,404.2 3,236.1 3,038.0 2,816.2
7 2,939.0 3,594.8 3,955.1 4,121.6 4,157.6 4,103.6 3,981.6 3,817.6 3,619.9 3,397.1 3,155.1
10 3,444.5 4,086.2 4,396.9 4,509.1 4,497.4 4,405.3 4,258.9 4,074.9 3,863.8 3,632.7 3,386.5
315
NPV
5 000
4 000
4
3 000 3
2
2 000
1 000
1
0 L
0 1 2 3 4 5 6
Fig. 17.2 Dependence of NPV on leverage L at t 20 % in 2010: 1 for 2-year income from
investments; 2 for 5-year income from investments (the term for hardware depreciation); 3 for
7 years of investment income; 4 for 10 years of investment income
for the 5-year project. Optimum NPV is achieved approximately at L 1. More

accurate calculations show that the optimal value of NPV 2,133.7 million dollars
is achieved when L 1.1.
The level leverage with which Nastcom Plus has carried out its investment
projects (L 0.1) was lying in the vicinity of optimum and provided NPV 2,131.8
million dollars, which is just 2 million dollars less than the optimal value of NPV.
You can take it that, in 2011, investment in Nastcom Plus company has been
carried out with almost optimal structure.
Analysis of Investments in 2012 Using companys data, we compute the WACC,
ke, and NPV (Tables 17.8, 17.9, and 17.10; Fig. 17.4).
The companys investment structure in 2012 was the same as in 2011: equity
capital accounted for 50 %, and debt capital for 50 %, i.e., the leverage level was
equal to L 1. The term hardware for depreciation, into establishment of which
investment was done, was 5 years. Curve 2 (Fig. 17.4) corresponds to dependence
of NPV on leverage level for the 5-year project. Optimum NPV is achieved when
L 0.5. More accurate calculations show that the optimal value of NPV 1,987.7
million dollars is achieved when L 0.7 (Table 17.11, Fig. 17.5).
The level leverage, with which Nastcom Plus has carried out its investment
projects (L 0.1), did not correspond to optimum value (L 0.7) and provided
NPV 1,954.6 million dollars, which is 31.7 million dollars less than the optimal
value of NPV (Figs. 17.4 and 17.5; Tables 17.10 and 17.11).
Since the equipment can be operated after depreciation, one can estimate the
optimal leverage value is L 0.65, when the NPV 2,580.6 million dollars, which
is 51.7 million dollars more than nonoptimal values of NPV 2,528.9 million
17.1

Leverage level L
2 0.2367 0.3096 0.3824 0.4552 0.5280 0.6008 0.6736 0.7464 0.8192 0.8920 0.9649
5 0.2367 0.3063 0.3758 0.4452 0.5147 0.5841 0.6536 0.7230 0.7925 0.8619 0.9314
7 0.2367 0.3053 0.3738 0.4423 0.5107 0.5791 0.6480 0.7165 0.7850 0.8535 0.9220
10 0.2366 0.3044 0.3720 0.4396 0.5071 0.5746 0.6422 0.7097 0.7772 0.8447 0.9122
317
318
17

Leverage level L
2 0.2367 0.3142 0.3916 0.4690 0.5464 0.6239 0.7013 0.7787 0.8561 0.9335 1.0110
5 0.2367 0.3110 0.3853 0.4595 0.5338 0.6080 0.6822 0.7565 0.8307 0.9049 0.9791
7 0.2367 0.3100 0.3833 0.4565 0.5297 0.6029 0.6761 0.7493 0.8230 0.8963 0.9695
10 0.2366 0.3091 0.3813 0.4536 0.5258 0.5980 0.6702 0.7424 0.8146 0.8868 0.9589
17.1
Table 17.7 Net present value, NPV, of the company in 2011, million dollars
Leverage level L
2 418.8 460.5 415.8 302.3 133.3 80.9 332.5 615.0 923.5 1,254.0 1,603.1
5 1,704.2 2,025.4 2,131.8 2,089.9 1,943.2 1,721.0 1,443.5 1,124.7 774.8 400.9 8.5
7 2,203.4 2,558.0 2,650.5 2,576.1 2,392.2 2,134.4 1,825.6 1,480.7 1,105.7 715.0 309.8
10 2,648.2 2,982.3 3,028.1 2,907.1 2,685.2 2,399.5 2,071.6 1,715.0 1,338.0 946.0 542.9
319
NPV
4 000
3 000
2 000
1 000
4
3
0 2 L
1 000
1
2 000
0 1 2 3 4 5 6
level L 0.55, with NPV 3,043.5 million dollars, which is 98 million dollars
company.
17.1.2 The Dependence of NPV on the Equity Capital Value

and Coefficient
Let us investigate the dependence of NPV on the equity capital value and
coefficient (Tables 17.12, 17.13, 17.14, and 17.15; Figs. 17.6, 17.7, 17.8,
and 17.9).
With increase of the equity value, optimum is observed for all of the values
S when leverage level is approximately equal to L 0.7, and the optimum value as
well as the NPV value is growing with increasing S, as long as the project remains
effective (up to the leverage level approximately L 3.7).
With the decrease of the return on investment ( 0.5), the dependence of the
NPV on leverage changes significantly: now NPV monotonically decreases with the
leverage at all values of equity capital S (Fig. 17.7).
With the increase of the return on investment ( 1.5), the NPV of the
project has an optimum at all values of equity capital S at leverage level
L 1.5, and NPV(L ) curve is going up with the increase in S until the project
remains effective (up to the leverage level approximately L 7). The optimum
position (value L0) almost does not depend on the equity value S (L0 1.5). This
means the possibility of a tabulation of obtained results by the known values
17.1

Leverage level L
2 0.2367 0.2298 0.2264 0.2243 0.2229 0.2219 0.2212 0.2206 0.2202 0.2198 0.2195
5 0.2367 0.2278 0.2234 0.2207 0.2189 0.2176 0.2167 0.2159 0.2153 0.2148 0.2144
7 0.2367 0.2272 0.2224 0.2195 0.2176 0.2162 0.2152 0.2143 0.2137 0.2132 0.2127
10 0.2366 0.2265 0.2213 0.2183 0.2162 0.2147 0.2136 0.2127 0.2120 0.2115 0.2110
321
322
17

Leverage level L
2 0.2367 0.3180 0.3992 0.4805 0.5617 0.6430 0.7242 0.8055 0.8867 0.9680 1.0492
5 0.2367 0.3150 0.3933 0.4715 0.5497 0.6279 0.7062 0.7844 0.8626 0.9408 1.0190
7 0.2367 0.3140 0.3913 0.4685 0.5457 0.6229 0.7001 0.7772 0.8544 0.9316 1.0088
10 0.2366 0.3130 0.3892 0.4653 0.5415 0.6177 0.6938 0.7699 0.8461 0.9222 0.9983
17.1
Table 17.10 Net present value, NPV, in 2012, million dollars

Leverage level L
2 267.0 200.9 33.4 214.0 525.3 888.3 1,293.4 1,733.4 2,202.4 2,695.8 3,209.9
5 1,734.8 1,968.9 1,954.6 1,771.8 1,472.1 1,089.6 647.1 160.6 358.9 903.4 1,467.2
7 2,304.7 2,566.9 2,528.9 2,304.4 1,960.4 1,537.2 1,060.3 545.9 4.7 556.0 1,131.2
10 2,812.6 3,041.6 2,945.5 2,667.4 2,281.9 1,829.9 1,335.0 811.1 266.8 292.2 862.1
323
NPV
5 000
3 000
1 000
0 L
4
1 000 3
2
3 000
1
5 000
0 1 2 3 4 5 6
k0 and kd for large values 1, when in dependence of NPV(L ) there is an

optimum.
With the further increase of the return on investment ( 2), NPV of the project
has an optimum for all values S at leverage level which is already approximately
equal to L 1.8, and the value of optimum as well as of NPV in general is growing
with increasing S, until the project remains an effective (up to leverage level of
order L 8.5, see Fig. 17.9).
In this way, the analysis of the dependence of NPV on the equity value S and
on the return on investment allows us to conclude that in contrast to the
parameters I and NOI, the change of parameters S and , both individually and
simultaneously, can significantly change the nature of the dependence of NPV on
leverage level.
With the increase of return on investment (with the increased ), there is a
transition from the monotonic decrease of NPV of the project with leverage
(Fig. 17.7) to the existing of the optimum at all values of S (see Figs. 17.6 and
17.8). The growth of leads to the growth of NPV as well as to the growth of the
limit leverage value, up to which the project remains effective.
This means the inability of tabulation of the results, obtained in the general
case of a constant value of equity capital; in this case, it is necessary to use the
formulas obtained by authors in their works (Brusov and Filatova 2011; Brusov
et al. 2011a, b, c, 2012a, b, 2013a, b, 2014a, b; Filatova et al. 2008) to
determine the NPV at the existing leverage level as well as for optimization
of existing investment structure. Tabulation is possible only in the case of large
values ( 1), when there is an optimum in the dependence of NPV on the
leverage level.
17.1
Table 17.11 Net present value, NPV, at leverage level from 0.5 up to 1.05 in 2012, million dollars
Leverage level L
Project duration n 0.5 0.55 0.6 0.65 0.7 0.75 0.8 0.85 0.9 0.95 1 1.05
2 200.9 188.3 174.8 160.2 144.8 128.4 111.1 92.9 73.9 54.1 33.4 12.0
5 1,968.9 1,977.0 1,982.8 1,986.3 1,987.7 1,987.0 1,984.2 1,979.5 1,973.0 1,964.6 1,954.6 1,942.8
7 2,566.9 2,574.2 2,578.8 2,580.6 2,580.0 2,576.9 2,571.5 2,563.9 2,554.2 2,542.5 2,528.9 2,513.5
10 3,041.6 3,043.5 3,042.4 3,038.5 3,032.0 3,023.1 3,011.7 2,998.2 2,982.6 2,965.0 2,945.5 2,924.3
325
NPV
4 000
3 000 4
3
2 000 2
1 000
1
0 L
0.3 0.4 0.5 0.6 0.7 0.8 0.9 1 1.1 1.2
Fig. 17.5 Dependence of NPV on leverage L at t 20 % in 2012 in the vicinity of optimum: 1 for
2-year income from investments; 2 for 5-year income from investments (the term for hardware
depreciation); 3 for 7 years of investment income; 4 for 10 years of investment income
17.2 Effects of Taxation on the Optimal Capital Structure

of Companies in the Telecommunication Sector
We continue the analysis of activity of Nastcom Plus. In this paragraph, we

examine the effect of change of tax on profit rate, both in the case of its increase
and decrease, on the optimal structure of investments at different project
durations.
It is shown that the increase of tax on profit rate leads to the degradation
(decreasing) of NPV, and the degradation is reduced with an increase of project
duration. In particular, for the 5-year project (amortization period), when the
tax on profit rate decreases on 1 %, NPV decreases on 1.52.34 % in different
years.
The impact of change of tax on the profit rate on the optimum position while
it exists (change optimum position) is changed for 2-year and 10-year projects
in 2010 and for the 5-year project in the 2012 year [for 0.51 (in L units)];
nevertheless the optimum position turns out to be sufficiently stable
(Figs. 17.10, 17.11, 17.12, 17.13, 17.14, 17.15, 17.16, 17.17, 17.18, 17.19,
17.20, and 17.21; Tables 17.16, 17.17, 17.18, 17.19, 17.20, and 17.21).
It is shown that the increase of tax on profit rate leads to the degradation
(decreasing) of NPV, and the degradation is reduced with an increase of project
duration. Note that for the 5-year project (amortization period), when the tax on
profit rate decreases by 1 %, NPV decreases by 2.34 % in 2012, by 2.04 % in
2011, and by 1.49 % in 2010.
17.2
Table 17.12 Net present value, NPV, at 1.02, million dollars

Leverage level L
Equity S 0 0.5 1 1.5 2 2.5 3 3.5 4 4.5 5
1,382 1,734.8 1,968.9 1,954.6 1,771.8 1,472.1 1,089.6 647.1 160.6 358.9 903.4 1,467.2
1,000 1,255.7 1,425.2 1,414.8 1,282.5 1,065.6 788.7 468.4 116.2 259.8 653.9 1,062.0
1,200 1,506.8 1,710.2 1,697.8 1539.0 1,278.7 946.4 562.1 139.5 311.8 784.7 1,274.4
1,600 2,009.1 2,280.3 2,263.7 2,052.0 1,705.0 1,261.9 749.5 186.0 415.7 1,046.3 1,699.2
1,800 2,260.3 2,565.3 2,546.7 2,308.5 1,918.1 1,419.7 843.2 209.2 467.6 1,177.1 1,911.6
Effects of Taxation on the Optimal Capital Structure of Companies in the. . .
327
328
17

Leverage level L
Equity S 0 0.5 1 1.5 2 2.5 3 3.5 4 4.5 5
1,382 146.1 71.8 411.5 833.8 1,313.3 1,833.5 2,383.1 2,954.2 3,541.6 4,141.1 4,750.2
1,000 105.7 52.0 297.9 603.5 950.7 1,327.2 1,725.0 2,138.4 2,563.6 2,997.6 3,438.4
1,200 126.9 62.4 357.4 724.2 1,140.8 1,592.6 2,070.0 2,566.1 3,076.3 3,597.1 4,126.1
1,600 169.2 83.2 476.6 965.6 1,521.0 2,123.5 2,760.0 3,421.5 4,101.7 4,796.1 5,501.4
1,800 190.3 93.6 536.2 1,086.3 1,711.2 2,388.9 3,105.0 3,849.2 4,614.4 5,395.6 6,189.1
17.2

Leverage level L
Equity S 0 0.5 1 1.5 2 2.5 3 3.5 4 4.5 5
1,382 3,201.2 3,852.6 4,138.6 4,176.9 4,043.3 3,787.8 3,444.2 3,035.8 2,578.9 2,085.3 1,563.3
1,000 2,317.2 2,788.7 2,995.8 3,023.5 2,926.8 2,741.8 2,493.1 2,197.5 1,866.7 1,509.4 1,131.6
1,200 2,780.7 3,346.5 3,594.9 3,628.2 3,512.1 3,290.2 2,991.7 2,637.0 2,240.1 1,811.3 1,357.9
1,600 3,707.5 4,462.0 4,793.2 4,837.6 4,682.8 4,386.9 3,989.0 3,515.9 2,986.8 2,415.1 1,810.6
1,800 4,171.0 5,019.7 5,392.4 5,442.3 5,268.2 4,935.3 4,487.6 3,955.4 3,360.1 2,716.9 2,036.9
Effects of Taxation on the Optimal Capital Structure of Companies in the. . .
329
330
17

Leverage level L
Equity S 0 0.5 1 1.5 2 2.5 3 3.5 4 4.5 5
1,382 4,728.8 5,814.9 6,413.7 6,682.3 6,721.7 6,598.5 6,357.9 6,030.8 5,639.2 5,198.5 4,720.0
1,000 3,423.0 4,209.1 4,642.6 4,837.0 4,865.5 4,776.3 4,602.2 4,365.4 4,081.9 3,762.9 3,416.6
1,200 4,107.5 5,050.9 5,571.1 5,804.4 5,838.6 5,731.6 5,522.6 5,238.5 4,898.3 4,515.5 4,099.9
1,600 5,476.7 6,734.5 7,428.1 7,739.2 7,784.8 7,642.1 7,363.4 6,984.7 6,531.1 6,020.6 5,466.6
1,800 6,161.3 7,576.4 8,356.6 8,706.6 8,757.9 8,597.4 8,283.9 7,857.8 7,347.4 6,773.2 6,149.9
17.2 Effects of Taxation on the Optimal Capital Structure of Companies in the. . . 331
NPV
4 000
4
5
2 000
1 2 3
1 000
1 000
2 000 L
1 2 3 4 5 6
Fig. 17.6 Dependence of NPV on leverage at different values of equity cost S at 1.02, million
dollars: 1 S 1,382.2 million dollars; 2 S 1,000 million dollars; 3 S 1,200 million dollars; 4
S 1,600 million dollars; 5 S 1,800 million dollars
NPV
1 000
1 000
2 000
3 000
2
4 000 3
5 000 1
4
6 000
5
7 000 L
1 2 3 4 5 6
NPV
6 000
5 000
4 000
3 000
5
2 000 4
1
3
1 000 2
0 L
1 2 3 4 5 6
NPV
10 000
9 000
8 000
7 000
6 000
5 000
4 000
3 000
2 000
1 000
0 L
1 2 3 4 5 6
Fig. 17.9 Dependence of NPV on leverage at different values of equity cost S at 2, million
NPV 2010, n=2

2500.00
2000.00
T=0.15
1500.00 T=0.2
NPV
T=0.25
1000.00
500.00
0.00
0 2 4 6
L
Fig. 17.10 Dependence of NPV on leverage level L for three values of tax on profit rate:
T 15 %, 20 %, 25 % for the 2-year project in 2010
NPV 2010, n=5

4500.00
4000.00
3500.00
3000.00
2500.00 T=0.15
NPV
2000.00
T=0.2
1500.00
T=0.25
1000.00
500.00
0.00
0 2 4 6
L
Fig. 17.11 Dependence of NPV on leverage level L for three values of tax on profit rate:
T 15 %, 20 %, 25 % for the 5-year project in 2010
Fig. 17.12 Dependence of NPV 2010, n=7

NPV on leverage level L for 5000.00
rate: T 15 %, 20 %, 25 % 4000.00
for the 7-year project 3500.00
in 2010 3000.00
NPV
2500.00 T=0.15
2000.00 T=0.2
1500.00
T=0.25
1000.00
500.00
0.00
0 1 2 3 4 5 6
L

three values of tax on profit
5000.00
rate: T 15 %, 20 %, 25 %
in 2010
NPV
3000.00 T=0,15
T=0,2
2000.00
T=0,25
1000.00
0.00
0 2 4 6
L

rate: T 15 %, 20 %, 25 % 500.00
for the 2-year project
in 2011 0.00
0 2 4 6 T=0.15
NPV
-500.00
T=0.2
-1000.00 T=0.25
-1500.00
-2000.00
L

2500.00
rate: T 15 %, 20 %, 25 %
in 2011
1500.00 T=0.15
NPV
1000.00 T=0.2
T=0.25
500.00
0.00
0 1 2 3 4 5 6
-500.00
L

rate: T 15 %, 20 %, 25 %
2500.00
in 2011 2000.00
NPV
T=0.15
1500.00
T=0.2
1000.00
T=0.25
500.00
0.00
0 1 2 3 4 5 6
L

rate: T 15 %, 20 %, 25 % 3000.00
in 2011 2500.00
NPV
2000.00 T=0.15
1500.00 T=0.2
1000.00 T=0.25
500.00
0.00
0 1 2 3 4 5 6
L

1000.00
NPV 2012, n=2
NPV on leverage level L for
rate: T 15 %, 20 %, 25 % 0.00
for the 2-year project -500.00 0 2 4 6
in 2012
-1000.00
T=0.15
NPV
-1500.00
T=0.2
-2000.00
T=0.25
-2500.00
-3000.00
-3500.00
-4000.00
L

rate: T 15 %, 20 %, 25 %
1500.00
in 2012 1000.00
500.00 T=0.15
NPV
0.00 T=0.2
-500.00 0 2 4 6 T=0.25
-1000.00
-1500.00
-2000.00
L

rate: T 15 %, 20 %, 25 % 2500.00
in 2012 1500.00
1000.00 T=0.15
NPV
500.00 T=0.2
0.00 T=0.25
-500.00 0 1 2 3 4 5 6
-1000.00
-1500.00
-2000.00
L

rate: T 15 %, 20 %, 25 % 3000.00
in 2012 2000.00
1500.00 T=0.15
NPV
1000.00 T=0.2
500.00 T=0.25
0.00
-500.00 0 2 4 6
-1000.00
-1500.00
L
Table 17.16 Dependence of n

optimum position L0 of
2010, t 2 5 7 10
investment structure in 2010
on tax on profit rate and 15 % 3 2 2 2
project duration 20 % 2 2 2 1.5
25 % 2 2 2 2
Table 17.17 Absolute and 2010 t 2015 % t 2520 % On 5 % On 1 %

relative change of NPV with
increase/decrease of tax on n2 418/487 204 34 % 6.8 %
profit rate on 5 % (1 %) 5 266 273 7.45 % 1.49 %
in 2010 7 263 271 6.88 % 1.37 %
10 245 256 5.56 % 1.11 %

2011, t 2 5 7 10
on tax on profit rate and 15 % 0.5 1 1 1
project duration 20 % 0.5 1 1 1
25 % 0.5 1 1 1

increase/decrease of tax on n2 119 118 25.8 % 5.16 %
profit rate on 5 % (1 %) 5 222 223 10.2 % 2.04 %
in 2011 7 236 239 8.75 % 1.75 %
10 238 242 7.7 % 1.54 %

2012, t 2 5 7 10
on tax on profit rate and 15 % 0 1 0.5 0.5
project duration 20 % 0 0.5 0.5 0.5
25 % 0 0.5 0.5 0.5

increase/decrease of tax on n2 104 103 39 % 7.8 %
profit rate on 5 % (1 %) 5 229 229 11.7 % 2.34 %
in 2012 7 253 256 9.9 % 1.98 %
10 269 271 8.9 % 1.74 %
Conclusions In 2010, the company Nastcom Plus worked at leverage level

L 0.54 instead of optimal value L 2.0. The NPV loss amounted to 645 million
dollars.
In 2012, the company worked at leverage level L 1.0 instead of optimal value
L 0.7. The NPV loss amounted from 32 to 98 million dollars, depending on the
term of operation of equipment.
The authors have evaluated effectiveness of investment at existing level of debt
financing and have developed recommendations on the optimum level of leverage
for the Russian company Nastcom Plus in 20102012.
The results indicate that if in 2011 the financial structure of the investment of
Nastcom Plus was close to the optimal and NPV was only 2 million dollars less
than the optimal value, in 2010, when the leverage level was L 0.54, NPV was
645 million dollars less than optimal value (the optimal leverage level should be
equal to L 2).
In 2012 the leverage level, with which Nastcom Plus has carried out its
investment projects (L 0.1), did not correspond to optimum value (L 0.7) and
provided NPV 1,954.6 million dollars, which is 31.7 million dollars less than the
optimal value of NPV (Tables 17.10 and 17.11; Figs. 17.4 and 17.5).
Since the equipment can be operated after depreciation, one can estimate the
optimal leverage value is L 0.65, when the NPV 2,580.6 million dollars, which
is 51.7 million dollars more than nonoptimal values of NPV 2,528.9 million
level L 0.55, with NPV 3,043.5 million dollars, which is 98 million dollars
company.
References
(11):815824
doi:10.1080/23322039.2014.946150
Econ Rev 53:147175
19541957. Am Econ Rev 56:333391
Chapter 18
The Golden Age of the Company (Three
Colors of Companys Time)
In this chapter we return back to corporate finance in order to describe a very

important discovery, made by us recently (Brusov et al. 2015). We investigate the
dependence of attracting capital cost on the time of life (age) of company n at
various leverage levels, at various values of capital costs with the aim of define of
minimum cost of attracting capital. All calculations have been done within modern
theory of capital cost and capital structure by BrusovFilatovaOrekhova (Brusov
and Filatova 2011; Brusov et al. 2011a, b, c, 2012a, b, 2013a, b, 2014a, b; Filatova
et al. 2008; Brusova 2011).
It is shown for the first time that valuation of weighted average cost of
capital (WACC) in the ModiglianiMiller theory (odigliani and iller 1958,
1963, 1966) is not minimal and valuation of the company capitalization is not
maximal, as all financiers supposed up to now: at some age of the company, its
WACC value turns out to be lower than in ModiglianiMiller theory and com-
pany capitalization V turns out to be greater than V in ModiglianiMiller theory.
It is shown that, from the point of view of cost of attracting capital, there are two
types of dependences of WACC on the time of life (age) of company n: monotonic
descending of WACC with n and descending of WACC with passage through
minimum, followed by a limited growth (Brusov et al. 2015). The first type takes
place for the companies with low-cost capital, characteristic for the Western
companies. The second type takes place for higher capital costs of the company,
characteristic for the companies from developing countries, including the Russian
companies. This means that the latter companies, in contrast to the Western ones,
can take advantage of the benefits given at a certain stage of development by
discovered effect. Moreover, since the golden age of company depends on the
companys capital costs, by controlling them (e.g.,, by modifying the value of
dividend payments that reflect the equity cost), the company may extend its golden
age when the cost to attract capital becomes minimal (less than perpetuity limit)
and the capitalization of companies becomes maximal (above than perpetuity
assessment) up to a specified time interval.

DOI 10.1007/978-3-319-14732-1_18
340 18 The Golden Age of the Company (Three Colors of Companys Time)
It has been concluded that existing presentations concerning the results of the
theory of ModiglianiMiller (odigliani and iller 1958, 1963, 1966) in these
aspects are incorrect. We discuss the use of opened effects in developing economics.
Introduction It is well known that the company goes through several stages in its
development process: adolescence, maturity, and old age. Within the modern theory
of capital cost and capital structure by BrusvFiltvOrekhv (BFO theory)
Filatova et al. 2008; Brusova 2011), it is shown that the problem of the company
development has an interpretation, which is absolutely different from the generally
accepted one.
One of the most important problems in corporate finance is the problem of
capital cost and capital structure. Before 2008 there were just two kinds of valua-
tions of cost of capital: the first one was the first quantitative theory by Nobel Prize
winners Modigliani and Miller (1958, 1963, 1966), applicable to perpetuity (with
infinite lifetime) companies, and the second one was the valuation applicable to
1-year companies by Steve Myers (1984).
So, before 2008, when the modern theory of capital cost and capital structure by
BrusvFiltvOrekhv (BFO theory) has been created (Brusov and Filatova
Brusova 2011), only two points in time interval have been known: 1 year and infinity.
At that time Steve Myers (1984) has supposed that the ModiglianiMiller
(MM) theory (odigliani and iller 1958, 1963, 1966) gave the lowest assessment
for WACC and consequently, the highest assessment for company capitalization.
This means that the WACC monotonically descends with the time of life of com-
pany, n, approaching its perpetuity limit (Fig. 18.1), and, consequently, company
capitalization monotonically increases, approaching its perpetuity limit (Fig. 18.3).
Created in 2008 the modern theory of capital cost and capital structure by Brusv
FiltvOrekhv (BFO theory) (Brusov and Filatova 2011; Brusov et al. 2011a, b, c,
2012a, b, 2013a, b, 2014a, b; Filatova et al. 2008; Brusova 2011) turned out to be able to
make valuation of capital cost and company capitalization for companies with arbitrary
lifetime (of arbitrary age): this completes the whole time interval from n 1 up to
n 1. A lot of qualitative effects in corporate finance, investments, taxations, etc. has
been made within BFO theory.
In this chapter with BFO theory it is shown that Steve Myers suggestion (Myers
1984) turns out to be wrong.
Choosing of optimal capital structure of the company, i.e., proportion of debt
and equity, which minimizes the weighted average cost of capital and maximizes
the company capitalization, is one of the most important tasks of financial manager
and the management of a company. The search for an optimal capital structure
attracts the attention of economists and financiers during many tens of years. And it
is clear why: one can, nothing making but only by changing the proportion between
the values of equity capital and debt of the company, significantly enhance the
company capitalization, in other words fulfill the primary task, to reach the critical
goal of business management. Spend a little less of your own, loan slightly more
(or vice versa), and company capitalization reaches a maximum.
18 The Golden Age of the Company (Three Colors of Companys Time) 341
Before, the search for an optimal capital structure was made by studying the
dependence of WACC on leverage level in order to determine the optimal leverage
level L0, at which the WACC is minimal and capitalization V is maximal. Here we
apply an absolutely different method, studying the dependence of WACC on the
time of life (age) of company n. Note that before the appearance of BFO theory,
study of such kind of dependences was impossible due the absence of time
parameter in perpetuity ModiglianiMiller theory (odigliani and iller 1958,
1963, 1966).
As it is shown in this chapter, from the point of view of cost of capital, there are
two types of dependences of WACC on the time of life (age) of company n:
monotonic descending of WACC with n and descending of WACC with passage
through minimum, followed by a limited growth (Figs. 18.1 and 18.2) (Brusov
et al. 2015).
The first type of behavior is linked with the comment by Myers (1984) that the
ModiglianiMiller (MM) theory (odigliani and iller 1958, 1963, 1966) gives
the lowest assessment for WACC that, as shown by us within the BFO theory, is,
generally speaking, incorrect. The second type of behavior of dependence of
WACC on the time of life (age) of company n is descending of WACC with
passage through minimum, followed by a limited growth.
Thus, in the general case, the comment by Myers (1984) turns out to be wrong,
and in the life of company there is a golden age or the golden century when the
cost of attracting capital becomes minimal and company capitalization becomes
maximal (Figs. 18.2 and 18.3) (Brusov et al. 2015). In the life of company, the same
number of stages as usual can be allocated: youth, maturity, and old age. In youth the
WACC decreases with n, in the maturity the value of attracting capital cost becomes
minimal, and in the old age this cost grows, approaching its perpetuity limit.
So, figuratively speaking, a current investigation transforms black and white
business world (with monotonic descending of WACC with the time of life of
company n) into color business world (with descending of WACC with n with
passage through minimum, followed by a limited growth): really there are three
colors of companys time.
Fig. 18.1 Monotonic

dependence of WACC on
the lifetime (age) of the
company n
Fig. 18.2 Dependence of WACC on the lifetime (age) of the company n, showing descending of
WACC with passage through minimum and then showing a limited growth to perpetuity
(MM) limit
Fig. 18.3 Two kinds of dependences of WACC and company capitalization, V, on the life-
time (age) of the company n: 110 monotonic descending of WACC and monotonic increase
of company capitalization, V, with the lifetime of the company n; 220 descending of WACC
with passage through minimum and then showing a limited growth, and increase of V with passage
through maximum (at n0) and then a limited descending to perpetuity (MM) limit
The conclusion made in this chapter for the first time that the assessment of the
WACC in the theory of Modigliani and Miller (MM) (odigliani and iller
1958, 1963, 1966) is not the minimal and capitalization is not maximal seems to
be very significant and important.
18.1 Dependence of WACC on the Lifetime (Age) of the Companyn at Different. . . 343
18.1 Dependence of WACC on the Lifetime (Age)

of the Company n at Different Leverage Levels
In this section we study the dependence of WACC on the lifetime (age) of the
company n at different leverage levels.
For L 1 one has
Table 18.1 Dependence of L WACC k0 kd Wd t n ke

WACC on the lifetime of the
company n at L 1 1 0.1843 0.2 0.15 0.5 0.2 1 0.2487
1 0.1798 0.2 0.15 0.5 0.2 2 0.2397
1 0.1780 0.2 0.15 0.5 0.2 3 0.2360
1 0.1772 0.2 0.15 0.5 0.2 4 0.2345
1 0.1769 0.2 0.15 0.5 0.2 5 0.2339
1 0.1769 0.2 0.15 0.5 0.2 6 0.2338
1 0.1770 0.2 0.15 0.5 0.2 7 0.2340
1 0.1771 0.2 0.15 0.5 0.2 8 0.2343
1 0.1773 0.2 0.15 0.5 0.2 9 0.2346
1 0.1775 0.2 0.15 0.5 0.2 10 0.2351
For L 2 we have

company n at L 2 2 0.1791 0.2 0.15 0.66667 0.2 1 0.2974
2 0.1731 0.2 0.15 0.66667 0.2 2 0.2793
2 0.1706 0.2 0.15 0.66667 0.2 3 0.2719
2 0.1696 0.2 0.15 0.66667 0.2 4 0.2687
2 0.1692 0.2 0.15 0.66667 0.2 5 0.2675
2 0.1691 0.2 0.15 0.66667 0.2 6 0.2672
2 0.1692 0.2 0.15 0.66667 0.2 7 0.2675
2 0.1694 0.2 0.15 0.66667 0.2 8 0.2681
2 0.1696 0.2 0.15 0.66667 0.2 9 0.2689
2 0.1699 0.2 0.15 0.66667 0.2 10 0.2697
For L 3 one has


company n at L 3 3 0.1765 0.2 0.15 0.75 0.2 1 0.3461
3 0.1697 0.2 0.15 0.75 0.2 2 0.3189
3 0.1669 0.2 0.15 0.75 0.2 3 0.3078
3 0.1657 0.2 0.15 0.75 0.2 4 0.3029
3 0.1653 0.2 0.15 0.75 0.2 5 0.3010
3 0.1651 0.2 0.15 0.75 0.2 6 0.3006
3 0.1653 0.2 0.15 0.75 0.2 7 0.3010
3 0.1655 0.2 0.15 0.75 0.2 8 0.3019
3 0.1658 0.2 0.15 0.75 0.2 9 0.3030
3 0.1661 0.2 0.15 0.75 0.2 10 0.3042
For L 5 one has

company n at L 5 5 0.1739 0.2 0.15 0.83333 0.2 1 0.4435
5 0.1663 0.2 0.15 0.83333 0.2 2 0.3980
5 0.1632 0.2 0.15 0.83333 0.2 3 0.3795
5 0.1619 0.2 0.15 0.83333 0.2 4 0.3713
5 0.1613 0.2 0.15 0.83333 0.2 5 0.3680
5 0.1612 0.2 0.15 0.83333 0.2 6 0.3672
5 0.1613 0.2 0.15 0.83333 0.2 7 0.3679
5 0.1615 0.2 0.15 0.83333 0.2 8 0.3693
5 0.1619 0.2 0.15 0.83333 0.2 9 0.3711
5 0.1622 0.2 0.15 0.83333 0.2 10 0.3732
For L 7 one has

company n at L 7 7 0.1726 0.2 0.15 0.875 0.2 1 0.5409
7 0.1646 0.2 0.15 0.875 0.2 2 0.4771
7 0.1614 0.2 0.15 0.875 0.2 3 0.4511
7 0.1599 0.2 0.15 0.875 0.2 4 0.4396
7 0.1594 0.2 0.15 0.875 0.2 5 0.4349
7 0.1592 0.2 0.15 0.875 0.2 6 0.4338
7 0.1593 0.2 0.15 0.875 0.2 7 0.4347
7 0.1596 0.2 0.15 0.875 0.2 8 0.4366
7 0.1599 0.2 0.15 0.875 0.2 9 0.4392
7 0.1603 0.2 0.15 0.875 0.2 10 0.4421
18.2 Dependence of WACC on the Lifetime (Age) of the Company n at. . . 345
Fig. 18.4 Dependence of WACC(n)

WACC on the lifetime (age) 0.1900
of the company n at 0.1850
different leverage levels 0.1800
L=1
WACC
0.1750
L=2
0.1700 L=3
0.1650 L=5
0.1600 L=7
0.1550
0 2 4 6 8 10 12
n
The analysis in Tables 18.1, 18.2, 18.3, 18.4, and 18.5 and Fig. 18.4 allows us to
make the following conclusions:
1. In all examined cases (at all leverage levels), at current values of capital costs
(equity, k0, and debt, kd, ones), the second type of behavior of dependence of
WACC on the lifetime (age) of the company, n, takes place, namely, descending
of WACC with n with passage through minimum with subsequent limited
growth.
2. The minimum cost of attracting capital (WACC) is achieved at all leverage
levels at the same companys age at n 6 (only when L 1, minimum is spread
for 2 years (n 5 and n 6)).
3. The value of minimum WACC, at a fixed n, significantly depends on the level of
leverage, L, and, of course, decreases with increasing L.

of the Company n at Different Values of Capital Costs
(Equity, k0, and Debt, kd) and Fixed Leverage Levels

company n at L 1, k0 8 %, 1 0.0758 0.08 0.04 0.5 0.2 1 0.1197
kd 4 % 1 0.0745 0.08 0.04 0.5 0.2 2 0.1170
1 0.0738 0.08 0.04 0.5 0.2 3 0.1157
1 0.0735 0.08 0.04 0.5 0.2 4 0.1149
1 0.0732 0.08 0.04 0.5 0.2 5 0.1144
1 0.0731 0.08 0.04 0.5 0.2 6 0.1141
1 0.0729 0.08 0.04 0.5 0.2 7 0.1139
1 0.0729 0.08 0.04 0.5 0.2 8 0.1137
1 0.0728 0.08 0.04 0.5 0.2 9 0.1136
1 0.0728 0.08 0.04 0.5 0.2 10 0.1135

WACC on the lifetime of
the company n at L 1, 1 0.1843 0.2 0.15 0.5 0.2 1 0.2487
k0 20 %, kd 15 % 1 0.1798 0.2 0.15 0.5 0.2 2 0.2397
1 0.1780 0.2 0.15 0.5 0.2 3 0.2360
1 0.1772 0.2 0.15 0.5 0.2 4 0.2345
1 0.1769 0.2 0.15 0.5 0.2 5 0.2339
1 0.1769 0.2 0.15 0.5 0.2 6 0.2338
1 0.1770 0.2 0.15 0.5 0.2 7 0.2340
1 0.1771 0.2 0.15 0.5 0.2 8 0.2343
1 0.1773 0.2 0.15 0.5 0.2 9 0.2346
1 0.1775 0.2 0.15 0.5 0.2 10 0.2351

0.1800
of the company n at
0.1600
different values of capital 0.1400
costs (equity, k0, and debt,
WACC
0.1200
kd, ones) and fixed leverage 0.1000
level L 1 0.0800 k0=0.2; kd=0.15
0.0600
k0=0.08, kd=0.04
0.0400
0.0200
0.0000
0 2 4 6 8 10 12
n
Put L 3.

company n at L 3, k0 3 0.1765 0.2 0.15 0.75 0.2 1 0.3461
20 %, kd 15 % 3 0.1697 0.2 0.15 0.75 0.2 2 0.3189
3 0.1669 0.2 0.15 0.75 0.2 3 0.3078
3 0.1657 0.2 0.15 0.75 0.2 4 0.3029
3 0.1653 0.2 0.15 0.75 0.2 5 0.3010
3 0.1651 0.2 0.15 0.75 0.2 6 0.3006
3 0.1653 0.2 0.15 0.75 0.2 7 0.3010
3 0.1655 0.2 0.15 0.75 0.2 8 0.3019
3 0.1658 0.2 0.15 0.75 0.2 9 0.3030
3 0.1661 0.2 0.15 0.75 0.2 10 0.3042

company n at L 3, k0 8 %, 3 0.0738 0.08 0.04 0.75 0.2 1 0.1991
kd 4 % 3 0.0717 0.08 0.04 0.75 0.2 2 0.1909
3 0.0707 0.08 0.04 0.75 0.2 3 0.1870
3 0.0702 0.08 0.04 0.75 0.2 4 0.1847
3 0.0698 0.08 0.04 0.75 0.2 5 0.1832
3 0.0696 0.08 0.04 0.75 0.2 6 0.1822
3 0.0694 0.08 0.04 0.75 0.2 7 0.1815
3 0.0693 0.08 0.04 0.75 0.2 8 0.1810
3 0.0692 0.08 0.04 0.75 0.2 9 0.1806
3 0.0691 0.08 0.04 0.75 0.2 10 0.1803

0.2000
WACC on the lifetime (age)
of the company n at
0.1500
different values of capital
WACC
costs (equity, k0, and debt, 0.1000

k0=0.2; kd=0.15
kd) and fixed leverage level
L3 0.0500 k0=0.08, kd=0.04
0.0000
0 2 4 6 8 10 12
n
The analysis in Tables 18.6, 18.7, 18.8, and 18.9 and Figs. 18.5 and 18.6 allows
us to make the following conclusions:
1. The type of behavior of dependence of WACC on the lifetime of the company, n,
at fixed leverage level significantly depends on values of capital costs (equity, k0,
and debt, kd). At the values of capital costs that are specific to developing
countries (including Russia) (k0 20 %, kd 15 %), there is a second type of
dependence of WACC on the lifetime (age) of the company, n, namely,
descending of WACC with n with passage through minimum with subsequent
limited growth. And at the capital cost values, characteristic to the West
(k0 8 %, kd 4 %), there is a first type of dependence of WACC on the time
of life (age) of company n, namely, the monotonic descending of WACC with n.
2. The same features are observed in both considering cases: at the leverage values
L 1 and L 3.

of the Company n at Different Values of Debt Capital
Cost, kd, and Fixed Equity Cost, k0, and Fixed
Leverage Levels
company n at different values of debt capital cost, kd, and fixed equity cost, k0, and
fixed leverage levels.
Put first L 1.

company n at L 1, k0 1 0.1843 0.2 0.15 0.5 0.2 1 0.2487
20 %, kd 15 % 1 0.1798 0.2 0.15 0.5 0.2 2 0.2397
1 0.1780 0.2 0.15 0.5 0.2 3 0.2360
1 0.1772 0.2 0.15 0.5 0.2 4 0.2345
1 0.1769 0.2 0.15 0.5 0.2 5 0.2339
1 0.1769 0.2 0.15 0.5 0.2 6 0.2338
1 0.1770 0.2 0.15 0.5 0.2 7 0.2340
1 0.1771 0.2 0.15 0.5 0.2 8 0.2343
1 0.1773 0.2 0.15 0.5 0.2 9 0.2346
1 0.1775 0.2 0.15 0.5 0.2 10 0.2351

company n at L 1, k0 1 0.1871 0.2 0.12 0.5 0.2 1 0.2783
20 %, kd 12 % 1 0.1832 0.2 0.12 0.5 0.2 2 0.2705
1 0.1815 0.2 0.12 0.5 0.2 3 0.2670
1 0.1807 0.2 0.12 0.5 0.2 4 0.2653
1 0.1802 0.2 0.12 0.5 0.2 5 0.2644
1 0.1799 0.2 0.12 0.5 0.2 6 0.2639
1 0.1798 0.2 0.12 0.5 0.2 7 0.2636
1 0.1798 0.2 0.12 0.5 0.2 8 0.2636
1 0.1798 0.2 0.12 0.5 0.2 9 0.2635
1 0.1798 0.2 0.12 0.5 0.2 10 0.2636
Table 18.12 Dependence L WACC k0 kd Wd t n ke

of WACC on the lifetime
of the company n at L 1, 1 0.1826 0.2 0.17 0.5 0.2 1 0.2291
k0 20 %, kd 17 % 1 0.1777 0.2 0.17 0.5 0.2 2 0.2194
1 0.1759 0.2 0.17 0.5 0.2 3 0.2158
1 0.1752 0.2 0.17 0.5 0.2 4 0.2144
1 0.1750 0.2 0.17 0.5 0.2 5 0.2141
1 0.1751 0.2 0.17 0.5 0.2 6 0.2143
1 0.1754 0.2 0.17 0.5 0.2 7 0.2148
1 0.1757 0.2 0.17 0.5 0.2 8 0.2154
1 0.1760 0.2 0.17 0.5 0.2 9 0.2160
1 0.1763 0.2 0.17 0.5 0.2 10 0.2167

company n at L 1, k0 1 0.1891 0.2 0.1 0.5 0.2 1 0.2982
20 %, kd 10 % 1 0.1857 0.2 0.1 0.5 0.2 2 0.2913
1 0.1841 0.2 0.1 0.5 0.2 3 0.2881
1 0.1832 0.2 0.1 0.5 0.2 4 0.2864
1 0.1827 0.2 0.1 0.5 0.2 5 0.2853
1 0.1823 0.2 0.1 0.5 0.2 6 0.2846
1 0.1821 0.2 0.1 0.5 0.2 7 0.2842
1 0.1819 0.2 0.1 0.5 0.2 8 0.2838
1 0.1818 0.2 0.1 0.5 0.2 9 0.2836
1 0.1817 0.2 0.1 0.5 0.2 10 0.2834

of the company n at 0.1880
different values of debt 0.1860
capital cost, kd, and fixed 0.1840
WACC
kd=0.15
equity cost, k0, and fixed 0.1820
leverage level L 1 0.1800 kd=0.12
0.1780 kd=0.17
0.1760 kd=0.1
0.1740
0 2 4 6 8 10 12
n
Put than L 3.

k0 20 %, kd 15 % 3 0.1697 0.2 0.15 0.75 0.2 2 0.3189
3 0.1669 0.2 0.15 0.75 0.2 3 0.3078
3 0.1657 0.2 0.15 0.75 0.2 4 0.3029
3 0.1653 0.2 0.15 0.75 0.2 5 0.3010
3 0.1651 0.2 0.15 0.75 0.2 6 0.3006
3 0.1653 0.2 0.15 0.75 0.2 7 0.3010
3 0.1655 0.2 0.15 0.75 0.2 8 0.3019
3 0.1658 0.2 0.15 0.75 0.2 9 0.3030
3 0.1661 0.2 0.15 0.75 0.2 10 0.3042

k0 20 %, kd 12 % 3 0.1748 0.2 0.12 0.75 0.2 2 0.4113
3 0.1722 0.2 0.12 0.75 0.2 3 0.4009
3 0.1709 0.2 0.12 0.75 0.2 4 0.3955
3 0.1702 0.2 0.12 0.75 0.2 5 0.3927
3 0.1698 0.2 0.12 0.75 0.2 6 0.3911
3 0.1696 0.2 0.12 0.75 0.2 7 0.3903
3 0.1695 0.2 0.12 0.75 0.2 8 0.3900
3 0.1695 0.2 0.12 0.75 0.2 9 0.3899
3 0.1695 0.2 0.12 0.75 0.2 10 0.3900

company n at L 3, k0 3 0.1738 0.2 0.17 0.75 0.2 1 0.2874
20 %, kd 17 % 3 0.1665 0.2 0.17 0.75 0.2 2 0.2581
3 0.1637 0.2 0.17 0.75 0.2 3 0.2469
3 0.1626 0.2 0.17 0.75 0.2 4 0.2426
3 0.1624 0.2 0.17 0.75 0.2 5 0.2415
3 0.1625 0.2 0.17 0.75 0.2 6 0.2420
3 0.1628 0.2 0.17 0.75 0.2 7 0.2433
3 0.1633 0.2 0.17 0.75 0.2 8 0.2451
3 0.1638 0.2 0.17 0.75 0.2 9 0.2470
3 0.1643 0.2 0.17 0.75 0.2 10 0.2490

company n at L 3, k0 3 0.1836 0.2 0.1 0.75 0.2 1 0.4945
20 %, kd 10 % 3 0.1785 0.2 0.1 0.75 0.2 2 0.4739
3 0.1761 0.2 0.1 0.75 0.2 3 0.4642
3 0.1747 0.2 0.1 0.75 0.2 4 0.4588
3 0.1739 0.2 0.1 0.75 0.2 5 0.4556
3 0.1734 0.2 0.1 0.75 0.2 6 0.4535
3 0.1730 0.2 0.1 0.75 0.2 7 0.4520
3 0.1727 0.2 0.1 0.75 0.2 8 0.4510
3 0.1726 0.2 0.1 0.75 0.2 9 0.4502
3 0.1724 0.2 0.1 0.75 0.2 10 0.4496

of the company n at
0.1800
different values of debt
capital cost, kd, and fixed
WACC
0.1750 kd=0.15
equity cost, k0, and fixed
kd=0.12
leverage level L 3 0.1700
kd=0.17
0.1650 kd=0.1
0.1600
0 2 4 6 8 10 12
n
The analysis in Tables 18.10, 18.11, 18.12, 18.13, 18.14, 18.15, 18.16, and 18.17
and Figs. 18.7 and 18.8 allows us to make the following conclusions:
1. At fixed equity cost, k0, and at fixed leverage level, the type of behavior of
dependence of WACC on the lifetime (age) of the company, n, significantly
depends on value of debt capital cost, kd: with growth of kd it is changing from
monotonic descending of WACC with n to descending of WACC with n with
passage through minimum with subsequent limited growth.
2. At kd 10 % and kd 12 % (k0 20 %), the monotonic descending of WACC
with n is observed, while at higher debt costs, kd 15 % and kd 17 %
(k0 20 %), descending of WACC with n with passage through minimum
with subsequent limited growth takes place. The optimum age of the company
is growing with kd decreasing: it is equal to 5 years at kd 17 % and 6 years at
kd 15 %.
3. The conclusions are saved at both considered values of leverage level: L 1 and
L 3.

of the Company n at Different Values of Equity Cost,
k0, and Fixed Debt Capital Cost, kd, and Fixed
Leverage Levels
company n at different values of equity cost, k0, and fixed debt capital cost, kd, and
fixed leverage levels.
company n at L 1, k0 1 0.1646 0.18 0.15 0.5 0.2 1 0.2092
18 %, kd 15 % 1 0.1602 0.18 0.15 0.5 0.2 2 0.2005
1 0.1585 0.18 0.15 0.5 0.2 3 0.1970
1 0.1578 0.18 0.15 0.5 0.2 4 0.1956
1 0.1576 0.18 0.15 0.5 0.2 5 0.1952
1 0.1576 0.18 0.15 0.5 0.2 6 0.1952
1 0.1578 0.18 0.15 0.5 0.2 7 0.1955
1 0.1580 0.18 0.15 0.5 0.2 8 0.1960
1 0.1583 0.18 0.15 0.5 0.2 9 0.1965
1 0.1585 0.18 0.15 0.5 0.2 10 0.1970

company n at L 1, k0 1 0.1843 0.2 0.15 0.5 0.2 1 0.2487
20 %, kd 15 % 1 0.1798 0.2 0.15 0.5 0.2 2 0.2397
1 0.1780 0.2 0.15 0.5 0.2 3 0.2360
1 0.1772 0.2 0.15 0.5 0.2 4 0.2345
1 0.1769 0.2 0.15 0.5 0.2 5 0.2339
1 0.1769 0.2 0.15 0.5 0.2 6 0.2338
1 0.1770 0.2 0.15 0.5 0.2 7 0.2340
1 0.1771 0.2 0.15 0.5 0.2 8 0.2343
1 0.1773 0.2 0.15 0.5 0.2 9 0.2346
1 0.1775 0.2 0.15 0.5 0.2 10 0.2351

company n at L 1, k0 1 0.2041 0.22 0.15 0.5 0.2 1 0.2882
22 %, kd 15 % 1 0.1994 0.22 0.15 0.5 0.2 2 0.2789
1 0.1975 0.22 0.15 0.5 0.2 3 0.2751
1 0.1967 0.22 0.15 0.5 0.2 4 0.2733
1 0.1963 0.22 0.15 0.5 0.2 5 0.2726
1 0.1962 0.22 0.15 0.5 0.2 6 0.2723
1 0.1962 0.22 0.15 0.5 0.2 7 0.2723
1 0.1962 0.22 0.15 0.5 0.2 8 0.2725
1 0.1964 0.22 0.15 0.5 0.2 9 0.2727
1 0.1965 0.22 0.15 0.5 0.2 10 0.2730

of the company n at
0.2000
different values of equity
cost, k0, and fixed debt
WACC
0.1500
capital cost, kd, and fixed k0=0.2
leverage level L 1 0.1000
k0=0.18
0.0500 k0=0.22
0.0000
0 2 4 6 8 10 12
n
Put L 3

company n at L 3, k0 3 0.1569 0.18 0.15 0.75 0.2 1 0.2677
18 %, kd 15 % 3 0.1503 0.18 0.15 0.75 0.2 2 0.2412
3 0.1477 0.18 0.15 0.75 0.2 3 0.2307
3 0.1466 0.18 0.15 0.75 0.2 4 0.2264
3 0.1462 0.18 0.15 0.75 0.2 5 0.2249
3 0.1462 0.18 0.15 0.75 0.2 6 0.2250
3 0.1464 0.18 0.15 0.75 0.2 7 0.2258
3 0.1468 0.18 0.15 0.75 0.2 8 0.2271
3 0.1471 0.18 0.15 0.75 0.2 9 0.2286
3 0.1475 0.18 0.15 0.75 0.2 10 0.2302

company n at L 3, k0 3 0.1765 0.2 0.15 0.75 0.2 1 0.3461
20 %, kd 15 % 3 0.1697 0.2 0.15 0.75 0.2 2 0.3189
3 0.1669 0.2 0.15 0.75 0.2 3 0.3078
3 0.1657 0.2 0.15 0.75 0.2 4 0.3029
3 0.1653 0.2 0.15 0.75 0.2 5 0.3010
3 0.1651 0.2 0.15 0.75 0.2 6 0.3006
3 0.1653 0.2 0.15 0.75 0.2 7 0.3010
3 0.1655 0.2 0.15 0.75 0.2 8 0.3019
3 0.1658 0.2 0.15 0.75 0.2 9 0.3030
3 0.1661 0.2 0.15 0.75 0.2 10 0.3042

company n at L 3, k0 3 0.1961 0.22 0.15 0.75 0.2 1 0.4245
22 %, kd 15 % 3 0.1891 0.22 0.15 0.75 0.2 2 0.3965
3 0.1862 0.22 0.15 0.75 0.2 3 0.3848
3 0.1849 0.22 0.15 0.75 0.2 4 0.3795
3 0.1843 0.22 0.15 0.75 0.2 5 0.3770
3 0.1840 0.22 0.15 0.75 0.2 6 0.3762
3 0.1840 0.22 0.15 0.75 0.2 7 0.3761
3 0.1841 0.22 0.15 0.75 0.2 8 0.3766
3 0.1843 0.22 0.15 0.75 0.2 9 0.3773
3 0.1845 0.22 0.15 0.75 0.2 10 0.3781

of the company n at
different values of equity 0.2000
cost, k0, and fixed debt
capital cost, kd, and fixed
WACC
0.1500
leverage level L 3 k0=0.2
0.1000 k0=0.18
k0=0.22
0.0500
0.0000
0 2 4 6 8 10 12
n
The analysis in Tables 18.18, 18.19, 18.20, 18.21, 18.22, and 18.23 and
Figs. 18.9 and 18.10 allows us to make the following conclusions:
1. At fixed debt capital cost, kd, and at fixed leverage level in all considered cases
(at all equity costs k0 and all leverage levels L), the second type of dependence of
WACC on the lifetime (age) of the company, n, namely, descending of WACC
with n with passage through minimum with subsequent limited growth, takes
place.
2. The golden age of the company slightly fluctuates under change of the equity
value k0; these fluctuations are described in Table 18.24 (age is in years).
Table 18.24 Dependence of k0

golden age of the company
L 18 % 20 % 22 %
n on L and k0
1 56 56 68
3 56 6 67

of the Company n at High Values of Capital Cost
(Equity, k0, and Debt, kd) and High Lifetime
of the Company
Let us study the dependence of WACC on the lifetime (age) of the company n at
high values of capital cost (equity, k0, and debt, kd) and high lifetime of the
company.
1. At Fixed Leverage Level

of the company n at high 0.3600
values of capital cost
(equity, k0 40 %, and 0.3500 L=1
WACC
debt, kd 35 %) at different 0.3400 L=2

leverage levels L (up to high L=3
values of lifetime of the 0.3300
L=5
company) 0.3200
L=7
0.3100
0 10 20 30 40 50
n
From Fig. 18.11 it follows that:

1. In all considered cases (at all leverage levels L ) at high values of capital cost
(equity, k0 40 %, and debt, kd 35 %), the second type of dependence of
WACC on the lifetime (age) of the company, n, namely, descending of WACC
with n with passage through minimum with subsequent limited growth up to
perpetuity limit, takes place.
2. A minimum value of attracting capital cost (WACC) is achieved at all leverage
levels in the same age, when n 4. This means that, at high value of capital
costs, the company age, at which minimal value of attracting capital cost is
achieved, is shifted forward lower (younger) values. We just remind that at
k0 20 % and kd 15 % (see above), the golden age was 6 years.
3. The shift of curves to lower values of WACC with increase of leverage level L is
associated with decrease of WACC with leverage.
4. An interesting thing is the analysis of the value of detected effect, i.e., how much
is the difference between the minimum of the attracting capital, found in the
BFO theory, and its perpetuity limit value, which has been considered as
minimal value up to now. In Table 18.25 the dependence of the difference
between the minimum of the attracting capital and its perpetuity limit value on
leverage level L is shown.
Perpetuity limit value of WACC is calculated by using ModiglianiMiller

formula (odigliani and iller 1958, 1963, 1966) with accounting of corporate
taxes:
WACC k0 1 wd t 18:1
From Fig. 18.11, it is seen that at high values of time of life (age) of company
(n 30), the WACC practically does not differ from its perpetuity limit.
Table 18.25 The difference between the optimal (minimal) value of WACC and its perpetuity
limit
L 1 2 3 5 7
WACC, % 0.72 0.99 1.12 1.25 1.33
From Table 18.25 it is seen that the gain value is from 0.7 % up to 1.5 % and
grows with the increase of the leverage level of company, L.
2. Under Change of the Debt Capital Cost, kd
Under change of the debt capital cost, kd, a depth of pit in dependence of WACC on
the time of life (age) of the company, n, is changed as well: from Fig. 18.12 it is
seen that pit (accounted from perpetuity value) is changed from 0.49 % (at kd 0.3)
up to 0.72 % (at kd 0.35).
Note that as it is seen from Fig. 18.12, a perpetuity limit of WACC does not
depend on debt cost, kd, that is in accordance with the ModiglianiMiller formula
(18.1) for WACC, which does not contain a debt capital cost, kd, that means
independence of perpetuity limit of WACC values from kd, while the intermediate
WACC values (for finite lifetime (age) of company, n) depend on the debt capital
cost, kd [see BFO theory (Brusov and Filatova 2011; Brusov et al. 2011a, b, c,
2012a, b, 2013a, b, 2014a, b; Filatova et al. 2008)].

0.3680
of the company n at fixed 0.3660
high value of equity cost, 0.3640
WACC
k0 40 %, and two values 0.3620

of debt cost, kd 30 % and 0.3600
kd=0.35
0.3580
35 %, at leverage level 0.3560 kd=0.3
L1 0.3540
0.3520
0.3500
0 10 20 30 40 50
n
Table 18.26 Dependence of WACC k0 kd L n t

company n at L 1, k0 18.2889 % 0.2 0.18 1 1 0.2
20 %, kd 18 % 17.4859 % 0.2 0.18 1 3 0.2
17.4155 % 0.2 0.18 1 5 0.2
17.4654 % 0.2 0.18 1 7 0.2
17.5833 % 0.2 0.18 1 10 0.2
17.8641 % 0.2 0.18 1 20 0.2
17.9629 % 0.2 0.18 1 30 0.2
17.9909 % 0.2 0.18 1 40 0.2

company n at L 1, k0 18.4736 % 0.2 0.15 1 1 0.2
20 %, kd 15 % 17.8200 % 0.2 0.15 1 3 0.2
17.6936 % 0.2 0.15 1 5 0.2
17.6967 % 0.2 0.15 1 7 0.2
17.7528 % 0.2 0.15 1 10 0.2
17.9192 % 0.2 0.15 1 20 0.2
17.9797 % 0.2 0.15 1 30 0.2
17.9957 % 0.2 0.15 1 40 0.2

company n at L 1, k0 18.6583 % 0.2 0.12 1 1 0.2
20 %, kd 12 % 18.1511 % 0.2 0.12 1 3 0.2
18.0181 % 0.2 0.12 1 5 0.2
17.9817 % 0.2 0.12 1 7 0.2
17.9789 % 0.2 0.12 1 10 0.2
18.0145 % 0.2 0.12 1 20 0.2
18.0175 % 0.2 0.12 1 30 0.2
18.0099 % 0.2 0.12 1 40 0.2

company n at L 1, k0 18.9082 % 0.2 0.1 1 1 0.2
20 %, kd 10 % 18.4030 % 0.2 0.1 1 3 0.2
18.2615 % 0.2 0.1 1 5 0.2
18.2045 % 0.2 0.1 1 7 0.2
18.1678 % 0.2 0.1 1 10 0.2
18.1146 % 0.2 0.1 1 20 0.2
18.0669 % 0.2 0.1 1 30 0.2
18.0330 % 0.2 0.1 1 40 0.2

company n at L 1, k0 19.1087 % 0.2 0.08 1 1 0.2
20 %, kd 8 % 18.6716 % 0.2 0.08 1 3 0.2
18.5297 % 0.2 0.08 1 5 0.2
18.4692 % 0.2 0.08 1 7 0.2
18.4040 % 0.2 0.08 1 10 0.2
18.2594 % 0.2 0.08 1 20 0.2
18.1532 % 0.2 0.08 1 30 0.2
18.0813 % 0.2 0.08 1 40 0.2
Fig. 18.13 Dependence of WACC(n), k0=0.2

WACC on the lifetime (age) 19.2000%
of the company n at fixed 19.0000%
value of equity cost, 18.8000%
18.6000%
k0 20 %, and at four 18.4000%
WACC
values of debt cost, 18.2000% Kd=0.18

kd 8 %, 10 %, 15 %, and 18.0000% Kd=0.15
18 %, at leverage level 17.8000%
Kd=0.10
L1 17.6000%
17.4000% Kd=0.08
17.2000%
0 10 20 30 40 50
n
From Fig. 18.13 it is seen, that with the increase of debt cost, kd, the character of
dependence of WACC on the lifetime (age) of the company n is changed from
monotonic descending of WACC with n to descending of WACC with n with
passage through minimum, followed by a limited growth (Tables 18.26, 18.27,
18.28, 18.29, and 18.30).
3. Under Change of the Equity Capital Cost, k0 (Tables 18.31, 18.32, 18.33,
18.34, 18.35, and 18.36)

company n at L 1, k0 23.2477 % 0.25 0.15 1 1 0.2
25 %, kd 15 % 22.6690 % 0.25 0.15 1 3 0.2
22.5117 % 0.25 0.15 1 5 0.2
22.4913 % 0.25 0.15 1 7 0.2
22.4933 % 0.25 0.15 1 10 0.2
22.5219 % 0.25 0.15 1 20 0.2
22.5136 % 0.25 0.15 1 30 0.2
22.5045 % 0.25 0.15 1 40 0.2

company n at L 1, k0 20.3006 % 0.22 0.15 1 1 0.2
22 %, kd 15 % 19.7431 % 0.22 0.15 1 3 0.2
19.6171 % 0.22 0.15 1 5 0.2
19.6163 % 0.22 0.15 1 7 0.2
19.6514 % 0.22 0.15 1 10 0.2
19.7639 % 0.22 0.15 1 20 0.2
19.7960 % 0.22 0.15 1 30 0.2
19.8007 % 0.22 0.15 1 40 0.2

company n at L 1, k0 18.4717 % 0.2 0.15 1 1 0.2
20 %, kd 15 % 17.8015 % 0.2 0.15 1 3 0.2
17.6938 % 0.2 0.15 1 5 0.2
17.6972 % 0.2 0.15 1 7 0.2
17.7592 % 0.2 0.15 1 10 0.2
17.9192 % 0.2 0.15 1 20 0.2
17.9797 % 0.2 0.15 1 30 0.2
17.9957 % 0.2 0.15 1 40 0.2

company n at L 1, k0 16.4350 % 0.18 0.15 1 1 0.2
18 %, kd 15 % 15.8519 % 0.18 0.15 1 3 0.2
15.7610 % 0.18 0.15 1 5 0.2
15.7793 % 0.18 0.15 1 7 0.2
15.8561 % 0.18 0.15 1 10 0.2
16.0683 % 0.18 0.15 1 20 0.2
16.1586 % 0.18 0.15 1 30 0.2
16.1884 % 0.18 0.15 1 40 0.2

company n at L 1, k0 14.4304 % 0.16 0.15 1 1 0.2
16 %, kd 15 % 13.9019 % 0.16 0.15 1 3 0.2
13.8278 % 0.16 0.15 1 5 0.2
13.8610 % 0.16 0.15 1 7 0.2
13.9481 % 0.16 0.15 1 10 0.2
14.2119 % 0.16 0.15 1 20 0.2
14.3324 % 0.16 0.15 1 30 0.2
14.3781 % 0.16 0.15 1 40 0.2
Table 18.36 Dependence of

k0 0.16 0.18 0.20 0.22 0.25
depth of gap WACC on k0
value WACC, % 0.55 0.43 0.30 0.18 0.03
Depth of gap, WACC, is decreased with equity cost, k0 (Fig. 18.14).

WACC on the lifetime (age)
value of debt cost,

kd 15 %, and five values 21.0000%
of equity cost, k0 16 %,
WACC
19.0000% Ko=0.25
18 %, 20 %, 22 %, and
Ko=0.22
25 %, at leverage level
L1 17.0000% Ko=0.2
Ko=0.18
15.0000% Ko=0.16
13.0000%
0 10 20 30 40 50
n
4. Under Change of the Tax on Profit Rate, t (Tables 18.37 and 18.38)
Table 18.37 Dependence of L WACC k0 kd t n

company n at L 2, k0 2 17.84 % 0.2 0.15 0.2 1
20 %, kd 15 %, t 20 % 2 17.07 % 0.2 0.15 0.2 3
2 16.92 % 0.2 0.15 0.2 5
2 16.92 % 0.2 0.15 0.2 7
2 16.99 % 0.2 0.15 0.2 10
2 17.12 % 0.2 0.15 0.2 15
2 17.30 % 0.2 0.15 0.2 30
2 17.33 % 0.2 0.15 0.2 45
Table 18.38 Dependence of L WACC k0 kd t n

company n at L 2, k0 2 15.72 % 0.2 0.15 0.4 1
20 %, kd 15 %, t 40 % 2 14.09 % 0.2 0.15 0.4 3
2 13.76 % 0.2 0.15 0.4 5
2 13.73 % 0.2 0.15 0.4 7
2 13.86 % 0.2 0.15 0.4 10
2 14.13 % 0.2 0.15 0.4 15
2 14.56 % 0.2 0.15 0.4 30
2 14.65 % 0.2 0.15 0.4 45
18.6 Further Investigation of Effect 361
The depth of gap in dependence of WACC on n, which is equal to 0.41 % at

t 0.2, is increased in 2.2 times and becomes equal to 0.92 % at t 0.4, i.e., it is
increased in 2.2 times, when tax on profit rate is increased in two times (Fig. 18.15).

capital costs, k0 20 %,
WACC
kd 15 %, and two values 16.00%
of tax on profit rate t 0.2 15.00% t=0.2
and t 0.4 and at leverage
t=0.4
level L 2 14.00%
13.00%
0 10 20 30 40 50
n

capital costs, k0 30 %, 28.00%
kd 15 %, and different
WACC
27.00% t=0
values of tax on profit rate 26.00% t=0.1
t 0, 0.1, 0.2, 0.3, and 0.4
25.00%
and at leverage level L 2 t=0.2
24.00%
t=0.3
23.00%
t=0.4
22.00%
0 10 20 30 40 50
n
We see from Fig. 18.16 that at fixed capital costs, k0 30 %, kd 15 %, and at

different values of tax on profit rate, t, there is no minimum in WACC at finite
lifetime (age) of the company: minimal value of WACC is reached at n 1. Note
that this is a feature of particular values of capital costs (probably, too big difference
between k0 and kd).
18.6 Further Investigation of Effect
During further investigation of effect, we have discovered one more interesting

feature of dependence of WACC on n, WACC(n): we have called this effect Kulik
effect (Kulik is a student of Management Department of Financial University in
Moscow, who has discovered this effect) (Brusov et al. 2015) (Tables 18.39 and
18.40).
Table 18.39 Dependence of L t k0 kd n Wd WACC

company n at L 1, k0 1 0.2 0.25 0.15 1 0.5 23.2270 %
25 %, kd 15 % 1 0.2 0.25 0.15 3 0.5 22.6725 %
1 0.2 0.25 0.15 5 0.5 22.5184 %
1 0.2 0.25 0.15 7 0.5 22.4914 %
1 0.2 0.25 0.15 10 0.5 22.4934 %
1 0.2 0.25 0.15 20 0.5 22.5220 %
1 0.2 0.25 0.15 30 0.5 22.5137 %
1 0.2 0.25 0.15 40 0.5 22.5045 %
1 0.2 0.25 0.15 1 0.5 21.50 %
Table 18.40 Dependence of L t k0 kd n Wd WACC

company n at L 2, k0 2 0.2 0.25 0.15 1 0.6667 22.8255 %
25 %, kd 15 % 2 0.2 0.25 0.15 3 0.6667 21.8935 %
2 0.2 0.25 0.15 5 0.6667 21.6843 %
2 0.2 0.25 0.15 7 0.6667 21.6431 %
2 0.2 0.25 0.15 10 0.6667 21.6448 %
2 0.2 0.25 0.15 20 0.6667 21.6895 %
2 0.2 0.25 0.15 30 0.6667 21.6842 %
2 0.2 0.25 0.15 40 0.6667 21.6742 %
2 0.2 0.25 0.15 1 0.6667 21.6665 %
Note that perpetuity limits for WACC(n), calculated by the ModiglianiMiller

formula (odigliani and iller 1958, 1963, 1966) (18.1), are equal to:
For L 1 WACC1 22.5 %
For L 2 WACC1 21.6665 % (Figs. 18.17, 18.18 and 18.19)

23.0000%
WACC
kd 15 %, and different 22.6000%

values of leverage level 22.4000%
22.2000% L=1
L 1 and L 2 22.0000%
21.8000% L=2
21.6000%
21.4000%
0 10 20 30 40 50
n
18.6 Further Investigation of Effect 363

22.3000%
kd 15 %, and different
WACC
22.2000%
values of leverage level 22.1000%
L 1 and L 2 (lager scale) 22.0000% L=1
21.9000% L=2
21.8000%
21.7000%
21.6000%
0 10 20 30 40 50
n


WACC
kd 15 %, and different 22.5150%

22.5100%
values of leverage level L=1
22.5050%
L 1 and L 2 (the largest
22.5000% L=2
scale)
22.4950%
22.4900%
0 10 20 30 40 50
n
It turns out that at particular values of capital costs, for example, at k0 25 %,

kd 15 %, a third modification of dependences of WACC on the time of life (age)
of company n takes place: descending of WACC with passage through minimum,
followed by a growth with passage through maximum, and finally with trend to
perpetuity limit from bigger values (remind that at the second type of WACC(n)
behavior, the curve WACC(n) tends to perpetuity limit from lower values). We
have called this effect Kulik effect. It gives a third type of dependence of WACC
on the time of life (age) of company n, which is represented at Fig. 18.20.
Fig. 18.20 Kulik effect:

behavior 3 for WACC(n)
and 30 for V(n)
Conclusions In this chapter it is shown for the first time (Brusov et al. 2015) within
BFO theory (Brusov and Filatova 2011; Brusov et al. 2011a, b, c, 2012a, b, 2013a,
b, 2014a, b; Filatova et al. 2008) that valuation of WACC in the ModiglianiMiller
theory (odigliani and iller 1958, 1963, 1966) is not minimal and valuation of
the company capitalization is not maximal, as all financiers supposed up to now: at
some age of the company its WACC value turns out to be lower than in Modigliani
Miller theory and company capitalization V turns out to be greater than V in
ModiglianiMiller theory (odigliani and iller 1958, 1963, 1966). Thus, existing
presentations concerning the results of the ModiglianiMiller theory in this aspect
(Myers 1984) turn out to be incorrect (Brusov et al. 2015).
It is shown that from the point of view of cost of attracting capital, there are two
(really three) types of dependences of WACC on the time of life (age) of company
n: monotonic descending of WACC with n and descending of WACC with passage
through minimum, followed by a limited growth [there is a third modification of
dependences WACC(n) (Kulik behavior), which leaves all conclusions valid
(Brusov et al. 2015)]. The first type takes place for the companies with low-cost
capital, characteristic for the Western companies. The second type takes place for
higher-cost capital of the company, characteristic for companies from developing
countries (including Russia). This means that the latter companies, in contrast to the
Western ones, can take advantage of the benefits given at a certain stage of
development by discovered effect (Brusov et al. 2015). Moreover, since the golden
age of company depends on the companys capital costs, by controlling them (e.g.,
by modifying the value of dividend payments that reflects the equity cost), the
company may extend the golden age of the company when the cost to attract
capital becomes minimal (less than perpetuity limit) and the capitalization of
companies becomes maximal (above than perpetuity assessment) up to a specified
time interval.
References
(11):815824
References 365

capital structure, different from suggested by trade off theory. Cogent Econ Finance 2:113,
doi:10.1080/23322039.2014.946150
perpetuity limit ModiglianiMiller theory. J Rev Global Econ 3:175185
Brusov P, Filatova T, Orehova N, Kulik V (2015) The golden age of the company. J Rev Global
Econ 4:2142
Myers S (1984) The capital structure puzzle. J Finance 39(3):574592
Econ Rev 53:147175
19541957. Am Econ Rev 56:333391
Chapter 19
Conclusion
This book changes our understanding of corporate finance, investments, and taxa-
tion. It shows that the most used principles of financial management should be
changed in accordance to BFO theory. Many of discoveries made within this theory
still require interpretations and understanding as well as incorporation into real
finance and economy. But it is clear now that without very serious modification of
the conceptions of financial management, it is impossible to adequately manage
manufacture, investments, and taxation, as well as finance in general.
The book has destroyed some main existing principles of financial management:
among them is the trade-off theory, which was considered as a keystone of
formation of optimal capital structure of the company during many decades. It
was proved by us that the balance between advantages and shortcomings of debt
financing could not provide the optimal capital structure for the company at all (and
an explanation (nontrivial) to this fact has been done). A new mechanism of
formation of the companys optimal capital structure, different from the ones
suggested by trade-off theory, has been suggested in monograph.
Let us also mention the discovered qualitatively new effect in corporate finance:
decreasing of cost of equity ke with leverage L. This changes the conceptions of
dividend policy of company very significantly.
A very important discovery has been done recently by the authors within BFO
theory. It is shown for the first time that valuation of weighted average cost of
capital (WACC) in the ModiglianiMiller theory (perpetuity limit) (Modigliani
and 1958, 1963, 1966) is not minimal and valuation of the company capitalization is
not maximal, as all financiers supposed up to now: at some age of the company
(golden age), its WACC value turns out to be lower than in ModiglianiMiller
theory and company capitalization V turns out to be greater than V in Modigliani
Miller theory (see Chap. 18).
And we can see similar influence of the obtained results in many areas of finance
and economy. Not all results, obtained by authors, found reflection in a book via its
limited volume. Readers should look for recent papers by authors in journals.

DOI 10.1007/978-3-319-14732-1_19
368 19 Conclusion
In conclusion, we mention the applications of BFO theory in corporate

finance, investments, and taxation:
1. Companies and corporations
2. Rating agencies
3. Investment companies
4. Banks and credit organizations
5. Central banks
6. Ministry of finance
7. Valuation of business
8. Insurance companies
9. Financial reports (ISFR, GAAP, etc.)
10. Fiscal organizations
References
Econ Rev 53:147175
19541957. Am Econ Rev 56:333391

Peter Brusov, Tatiana Filatova, Natali Orekhova, Mukhadin Eskindarov Auth. Modern Corporate Finance, Investments and Taxation

Transféré par

Informations du document

Copyright

Formats disponibles

Partager ce document

Partager ou intégrer le document

Options de partage

Avez-vous trouvé ce document utile ?

Ce contenu est-il inapproprié ?

Droits d'auteur :

Formats disponibles

Peter Brusov, Tatiana Filatova, Natali Orekhova, Mukhadin Eskindarov Auth. Modern Corporate Finance, Investments and Taxation

Transféré par

Droits d'auteur :

Formats disponibles

PeterBrusov TatianaFilatova

Modern Corporate Finance,

Natali Orekhova Mukhadin Eskindarov

ISBN 978-3-319-14731-4 ISBN 978-3-319-14732-1 (eBook)

Library of Congress Control Number: 2015938761

Springer Cham Heidelberg New York Dordrecht London

Printed on acid-free paper

Springer International Publishing AG Switzerland is part of Springer Science+Business Media

4. Mechanism of formation of the company optimal capital structure, different

This book is intended for students, postgraduate students, teachers of economic

49 Leningradsky Ave. Peter Brusov

Part I Corporate Finance

4 Bankruptcy of the Famous Trade-Off Theory . . . . . . . . . . . . . . . . 47

8.4 Practical Value of Effect . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 128

11.6 ModiglianiMiller Limit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 179

14.3 The Effectiveness of the Investment Project from

17.2 Effects of Taxation on the Optimal Capital Structure

Springer International Publishing Switzerland 2015 3

Such an incorrect assessment of key performance indicators of financial activ-

The second part of this monograph is devoted to assess effectiveness of the

2.1 The Traditional Approach

Springer International Publishing Switzerland 2015 9

approach has existed up to appearance of the first quantitative theory by Modigliani

2.2 ModiglianiMiller Theory

2.2.1 ModiglianiMiller Theory Without Taxes

Fig. 2.1 Dependence of

Index L means financially dependent company (using debt financing), while

V0 VL; CF=k0 CF=WACC, and thus WACC k0 :

Note that first ModiglianiMiller theorem is based on suggestion about indepen-

Finding from here ke, one gets

Thus, we come to second statement (theorem) of ModiglianiMiller theory

2.2.2 ModiglianiMiller Theory with Taxes

Fig. 2.2 Dependence of

and the cost of leverage company is equal to

where V0 is the value of financially independent company.

V CF=k0 wd VT: 2:7

Because the value of leverage company is V CF=WACC, for weighted average

WACC k0 1 LT=1 L: 2:9

Equating Eqs. (2.9) and (2.11), one gets

Fig. 2.3 Dependence of

2.2.3 Main Assumptions of ModiglianiMiller Theory

The most important assumptions of the ModiglianiMiller theory are as following:

2.2.4 Modifications of ModiglianiMiller theory

The equity cost for company with debt capital:

The debt cost:

The weighted average cost of capital WACC

here ta moment of payment a credit, N d 1 cumulative normal distribution of

CFL CFe CFd EBIT I 1 T C 1 T S I 1 T D ; 2:23

where I is the annual interest payments on debt.

CFL CFe CFd EBIT1 T C 1 T S I 1 T C 1 T S

is equal to market value of the debt D. Substituting D in the previous formula, we

Theory Main thesis

One of the serious limitations of the ModiglianiMiller theory is the suggestion

Springer International Publishing Switzerland 2015 27

3.1 Companies with Arbitrary Lifetime (Arbitrary Age):

V 0 CF=k0 and V CF=WACC: 3:5

V 0 CF1 1 k0 n =k0 ; V CF1 1 WACCn =WACC: 3:6

From formula (Eq. 3.4), we get BrusovFilatovaOrekhova equation for WACC

Here, Sthe value of equity capital of the company, wd DS D

For n 2, one has

This equation can be solved for WACC analytically:

The algorithm of the solving of the Eq. (3.12) should be as follows:

3.2 Comparison of ModiglianiMiller Results (Perpetuity

3.3 BrusovFilatovaOrekhova Theorem

2. WACC we ke wd kd ; and thus

WACC2 2 1 WACC 2 0: 3:22

leverage from k0 [in the absence of debt financing