1. Analytical Methods for Lawyers
Finance Unit
Last updated 01 Mar 07

2. Schedule Class Topic 3/1 Introduction Spreadsheet primer 3/6
TVM – future value
Exercise 1
3/8
TVM – present value
Exercise 2
3/20
Discount rate
Exercise 3
3/22
ECMH
Readings
3/27
Risk and return
Exercise 4
3/29
Valuation – medical malpractice
Group problem 1
4/3
Valuation – corporate appraisal
Group problem 2

3. Why the firm?

4. Theory of the Firm Labor Capital Firm Supplies Equipment Land
Adam Smith
“Wealth of Nations”
Land

5. Why not contracting?

6. Theory of the Firm Capital Labor Entrepreneur Supplies Equipment Land
Ronald Coase
“Nature of the Firm”
Land

7. Theory of the Firm Capital Labor Entrepreneur Supplies Equipment Land
Ronald Coase
“Nature of the Firm”
Land

8. What is the modern public corporation?

9. Separation of ownership/control
Entrepreneurs
(capitalist managers)
Labor
Capital
Supplies
Equipment
Adolf Berle &
Gardiner Means
Land

10. Separation of ownership/control
Professional
managers
Capital
(diffuse public
ownership)
Labor
Supplies
Equipment
Adolf Berle &
Gardiner Means
Land

11. What is ideal ownership – debt or equity?

12. Optimal debt-equity mix
Managers
Equity
Labor
Debt
Franco Modigliani &
Merton Miller
“Cost of Capital”
Supplies
Equipment
Land

13. Optimal debt/equity mix
Priority
Fixed rate of return
Net
Assets
Debt
Optimal
debt/equity?
Equity
Equity:
Voting control
Residual returns

14. Optimal debt/equity mix
Less debt:
Large equity cushion
Lower risk  lower cost
Net
Assets
Debt
Equity
Optimal
debt/equity?
More equity:
Low leverage
Lower returns  higher cost

15. Optimal debt/equity mix
More debt:
Small equity cushion
Higher risk  higher cost
Net
Assets
Debt
Optimal
debt/equity?
Equity
Less equity:
High leverage
High returns  lower cost

16. Average cost of capital
Modigliani & Miller
Return on Assets
Cost of debt
Cost of equity
Average cost of capital
High D/E (90/10)
15%
14%
24%
Mid D/E (50/50)
10%
20%
Low D/E (10/90) 6%
16%

17. Average cost of capital
Modigliani & Miller
Return on Assets
Cost of debt
Cost of equity
Average cost of capital
High D/E (90/10)
15%
14%
24%
Mid D/E (50/50)
10%
20%
Low D/E (10/90) 6%
16%

18. Average cost of capital
Modigliani & Miller
Return on Assets
Cost of debt
Cost of equity
Average cost of capital
High D/E (90/10)
15%
14%
24%
Mid D/E (50/50)
10%
20%
Low D/E (10/90) 6%
16%

19. Average cost of capital
Modigliani & Miller
Return on Assets
Cost of debt
Cost of equity
Average cost of capital
High D/E (90/10)
15%
14%
24%
15%*
Mid D/E (50/50)
10%
20%
Low D/E (10/90) 6%
16%
* Interest is deductible (debt subsidized by govt)

20. How unify ownership and management?

21. “Managerial Behavior”
Leveraged firm
Managers
Outside
debt
Inside
equity
Labor
Michael Jensen &
William Meckling
“Managerial Behavior”
Supplies
Equipment
Land

23. END