ABSTRACT

Suvas, Arto (1994). Essays on valtion of the firm. Acta Wasaensia No 39, 192 p.

This study comprises five separate essays related to valuation of the firm. In the introduction to the essays, advances in the theory of valuation of the firm are outlined. Attention is drawn to the central role of the Modigliani-Miller (MM) theory in the current theory of corporation finance.

The first essay highlights an intuitively unappealing implication of the Modigliani-Miller (1963) model that has remained unnoticed or at least has not received due attention. An alternative definition of the cost of equity, which does not have this drawback, is presented.

The second essay re-examines the effect of growth opportunities on the current valuation of the firm under uncertainty. Both perpetual and finite horizon growth assumptions are covered

In the third essay, the original MM (1966) growth opportunities model, the MM variant proposed by Arditti and Pinkerton (AP) (1978), and the model presented in Essay 2 are compared. The three models are found to yield different solutions. Detailed analysis reveals that both MM and AP use inappropriate discount rates for the future net present values associated with growth opportunity investments.

Many respects of empirical evidence concerning factors affecting the valuation of shares are inconsistent. In the fourth essay, Finnish data are used to test several earlier models. The results are similar to those obtained with U.S. data. The risk variables (e.g. the market model beta) perform disturbingly poorly, as was the case in previous studies. The importance of growth is confirmed by a new specification that works well across the models tested.

The fifth essay examines determination of optimal capital structure of the firm as a function of bankruptcy costs, non-debt tax shields and personal taxes, assuming a multiperiod framework and risk aversion. The effects of personal taxes and non-debt tax shields are found to be of crucial importance, because optimal leverage solutions cannot be brought into the range consistent with observed debt-to-firm-value ratios, unless sufficient bankruptcy costs, realistic personal tax rates and nontrivial non-debt tax shields exist simultaneously.

Arto Suvas, Department of Accounting and Finance, Faculty of Accounting and Industrial Management, University of Vaasa, Wolffintie 36, FIN-65200 Vaasa, Finland.

theory of valuation of the firm, valuation of shares, cost of capital, Modigliani-Miller theory, growth of the firm, capital structure, probability of bankruptcy