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did not own the lease at $5 per square foot it would
have to rent more expensive space and, as a result,
both the earnings and the value of the company would be
lower. Of course the price an acquirer would pay is
the value of the earnings stream from the whole
company, i.e., its revenues less its total costs,
including the costs of space. However, it is clear
that paying $5 rather than $70 per square foot for
space increases the earnings of the company and
therefore has value to an acquirer.
Similarly, suppose two companies, A and B, have
identical assets and identical amounts of debt but pay
different rates of interest on their debt. Company A’s
liabilities pay the Prevailing Market Interest Rate
while company B’s liabilities pay a below-market
interest rate. In this case, company B’s earnings will
be higher than company A’s and an acquirer would
clearly pay more for company B than for company A. The
difference in the earnings of the two companies is the
difference between interest payments at the Prevailing
Market Interest Rate (the rate on company A’s
liabilities) and the lower rate on company B’s
liabilities. Thus, the difference between the earnings
of the two companies is equal to company B’s Favourable
Financing benefits and the higher amount that an
acquirer would pay for company B over company A is the
value of company B’s Favourable Financing Assets.
To further rebut respondent’s claim that favorable financing
cannot exceed the value of equity, Professor Schaefer explained:
This claim is clearly flawed since all that is required
for the value of the Favourable Financing Assets to
exceed the value of equity is for the present value of
the Asset Spread to Market[17] to be negative. * * *
17 Professor Schaefer describes Asset Spread to Market as
follows:
the difference between the rate the firm actually earns
on its assets and the rate it would earn if it had to
invest in the market (at the Prevailing Market Interest
Rate), measures the benefit to the firm of the specific
assets it holds. I refer to this rate as the Asset
Spread to Market. If positive, this difference
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