Peter Brusov · Tatiana Filatova 
Natali Orekhova · Mukhadin Eskindarov

Modern Corporate
Finance, Investments,
Taxation and Ratings
Second Edition


Modern Corporate Finance, Investments, Taxation
and Ratings


Peter Brusov • Tatiana Filatova •
Natali Orekhova • Mukhadin Eskindarov

Modern Corporate Finance,
Investments, Taxation and
Ratings

Second Edition


Peter Brusov
Financial University under
the Government of Russian Federation
Moscow, Russia

Tatiana Filatova
Financial University under
the Government of Russian Federation

Moscow, Russia

Natali Orekhova
Center of Corporate Finance, Investment,
Taxation and Ratings
The Research Consortium of Universities
of the South of Russia
Rostov-on-Don, Russia

Mukhadin Eskindarov
Financial University under
the Government of Russian Federation
Moscow, Russia

ISBN 978-3-319-99685-1
ISBN 978-3-319-99686-8
/>
(eBook)

Library of Congress Control Number: 2018955714
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100th Anniversary of the Financial University
under the Government of Russia Federation
Dedicated to our dear granddaughter Anyuta,
who likes very much to sing and dance,
and to her little sister Sofi


Preface to the Second Edition

In the 3 years since the first edition, new results have been obtained by authors in
corporate finance, investment, and taxation as well as in a new area—ratings and
rating methodologies—within the framework of Brusov, Filatova, and Orekhova
(BFO) theory. Some of them (not all) have been included in the second edition
(Chaps. 19, 20, 21, 22, 23, and 24 have been added).
Among them is the chapter entitled “A golden age of the companies: conditions
of its existence” (Chap. 19). Also, we have found a modification of “Kulik effect”:
descending of WACC with passage through minimum, which lies above the perpetuity limit value, and then going through maximum followed by a limited
descending. We call this company age, where WACC has a minimum, which lies
above the perpetuity limit value, “by a silver age” of the company.
In Chap. 20, we study the role of the Central Bank and commercial banks in
creating and maintaining a favorable investment climate in the country. Within the
framework of modern investment models created by the authors, the dependence of

the efficiency of investments, determined by net present value (NPV), on the level of
debt financing within a wide range of values of equity costs and debt capital costs
under different project terms (long-term projects as well as projects of arbitrary
duration) and different investment profitability coefficients β is investigated. The
study is conducted within the framework of investment models with debt repayment
at the end of the project term. It is found that NPV depends practically linearly on
leverage level L, increasing or decreasing depending on profitability coefficient β
and credit rate values kd. The cutoff credit rate values k∗
d , separating the range of
increasing NPV(L ) from the range of decreasing NPV(L), are determined. The
Central Bank should keep its key rate at the level which allows commercial banks
to keep their credit rates below the cutoff credit rate k ∗
d values in order to create and
maintain a favorable investment climate in the country.
The most significant addition to the second edition is Part IV, devoted to the
discussion of ratings and rating methodologies. The shortcomings of existing rating
methodologies are discussed and analyzed, and a new approach to rating methodology has been suggested in Chaps. 21, 22, and 23: Chaps. 21 and 22 are devoted to
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Preface to the Second Edition

rating of non-financial issuers, while Chap. 23 is devoted to long-term project rating.
The key factors of the new approach are (1) the adequate use of discounting of
financial flows virtually not used in existing rating methodologies and (2) the
incorporation of rating parameters (financial “ratios”) into the modern theory of
capital structure [Brusov–Filatova–Orekhova (BFO) theory] (in Chap. 21 into its
perpetuity limit). This, on the one hand, allows us to use the powerful tools of this

theory in the rating, and on the other hand, it ensures the correct discount rates when
discounting of financial flows. We discuss also the interplay between rating ratios
and leverage level, which can be quite important in rating. All these create a new
base for rating methodologies.1
The new approach to ratings and rating methodologies allows issue more correct
ratings of issuers, making the rating methodologies more understandable and
transparent.
We call the modified form of BFO theory for rating needs BFO-3 theory. Thus, in
the monograph we describe three modifications of BFO theory:
BFO-1, which is applicable to describe the companies of arbitrary age;
BFO-2, which is applicable to describe companies of arbitrary lifetime when company ceased to exist at the arbitrary time moment n;
BFO-3, which is applicable for rating needs.
This book is intended for both undergraduate and postgraduate students, students
of MBA program, teachers of economic and financial universities, 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.
Kronburg, Moscow, Russia
23 June 2018

Peter Brusov

1
The study in Chaps. 21, 22, and 23 was funded by RFBR according to the research project №1706-00251A.


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 Modigliani–
Miller concerning the perpetuity (infinite time of life) of companies and further
elaborated quantitative theory of valuation of key parameters of financial 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
Modigliani–Miller theory. They show that the latter, via its perpetuity, underestimates the assessment of weighted average cost of capital, WACC, 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 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: abnormal dependence of equity cost on leverage, which alters the main principles of the
company’s 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 Modigliani–Miller 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.

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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 Modigliani–Miller as well as in Brusov–Filatova–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 company’s 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 Brusov–Filatova–Orekhova theory allows to correctly identify
discount rates—basic 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

xi

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 agencies, officials of regional and federal ministries and departments, and ministers
responsible for economic and financial management.
Moscow, Russia
4 February 2014

Peter Brusov


Contents

Part I


Corporate Finance

1

Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

3
6

2

Capital Structure: Modigliani–Miller Theory . . . . . . . . . . . . . . . .
2.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2.2 The Traditional Approach . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2.3 Modigliani–Miller Theory . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2.3.1
Modigliani–Miller Theory Without Taxes . . . . . . . . .
2.3.2
Modigliani–Miller Theory with Taxes . . . . . . . . . . . .
2.3.3
Main Assumptions of Modigliani–Miller Theory . . . .
2.3.4
Modifications of Modigliani–Miller Theory . . . . . . . .
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

9
9
10
11

11
13
16
17
27

3

Modern Theory of Capital Cost and Capital Structure:
Brusov–Filatova–Orekhova Theory (BFO Theory) . . . . . . . . . . . . .
3.1 Companies of Arbitrary Age and Companies with Arbitrary
Lifetime: Brusov–Filatova–Orekhova Equation . . . . . . . . . . . . . .
3.2 Comparison of Modigliani–Miller Results (Perpetuity Company)
with Myers Results (1-Year Company) and Brusov–Filatova–
Orekhova Ones (Company of Arbitrary Age) . . . . . . . . . . . . . . .
3.3 Brusov–Filatova–Orekhova Theorem . . . . . . . . . . . . . . . . . . . . .
3.4 From Modigliani–Miller to General Theory of Capital Cost
and Capital Structure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
3.5 BFO Theory in the Case, When the Company Ceased to Exist
at the Time Moment n (BFO-2 Theory) . . . . . . . . . . . . . . . . . . .
3.5.1
Application of Formula BFO-2 . . . . . . . . . . . . . . . . . .
3.5.2
Comparison of Results Obtained from Formulas BFO
and BFO-2 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

.
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.

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.

29
30

32
36
40
43
44
46

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xiv

4

5

Contents

3.6 Conclusions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .


47
49

Bankruptcy of the Famous Trade-Off Theory . . . . . . . . . . . . . . . .
4.1 Optimal Capital Structure of the Company . . . . . . . . . . . . . . . .
4.2 Absence of the Optimal Capital Structure in Modified
Modigliani–Miller Theory (MMM Theory) . . . . . . . . . . . . . . . .
4.3 Analysis of the Trade-Off Theory Within the Brusov–Filatova–
Orekhova Theory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
4.4 The Causes of Absence of the Optimum Capital Structure
in the Trade-Off Theory . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
4.5 Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

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51
51

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54

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55

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74
95
96

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99

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99

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113
115
116

New Mechanism of Formation of the Company’s Optimal Capital
Structure, Different from Suggested by Trade-Off Theory . . . . . .
5.1 Absence of Suggested Mechanism of Formation
of the Company’s Optimal Capital Structure Within Modified
Modigliani–Miller Theory (MMM Theory) . . . . . . . . . . . . . . . .
5.2 Formation of the Company’s Optimal Capital Structure Within

Brusov–Filatova–Orekhova (BFO) Theory . . . . . . . . . . . . . . . .
5.3 Simple Model of Proposed Mechanism . . . . . . . . . . . . . . . . . .
5.4 Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

6

The Global Causes of the Global Financial Crisis . . . . . . . . . . . . . . 119
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 124

7

The Role of Taxing and Leverage in Evaluation of Capital Cost and
Capitalization of the Company . . . . . . . . . . . . . . . . . . . . . . . . . . . .
7.1 The Role of Taxes in Modigliani–Miller Theory . . . . . . . . . . . . .
7.2 The Role of Taxes in Brusov–Filatova–Orekhova Theory . . . . . .
7.2.1
Weighted Average Cost of Capital (WACC)
of the Company . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
7.2.2
Equity Cost ke of the Company . . . . . . . . . . . . . . . . . .
7.2.3
Dependence of WACC and ke on the Age of
Company . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
7.3 Conclusions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

8

A Qualitatively New Effect in Corporate Finance: Abnormal

Dependence of Equity Cost of Company on Leverage . . . . . . . . . .
8.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
8.2 Equity Cost in the Modigliani–Miller Theory . . . . . . . . . . . . . .
8.3 Equity Cost Capital Within Brusov–Filatova–Orekhova
Theory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
8.3.1
Dependence of Equity Cost ke on Tax on Profit Rate
T at Different Fixed Leverage Level L . . . . . . . . . . . .

125
126
129
130
132
135
138
139

. 141
. 141
. 141
. 145
. 146


Contents

xv

8.3.2


9

Dependence of Equity Cost ke on Leverage Level
L (the Share of Debt Capital wd) at Different Fixed Tax
on Profit Rate T . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
8.4 Dependence of the Critical Value of Tax on Profit Rate T *
on Parameters n, k0, and kd of the Company . . . . . . . . . . . . . . . .
8.5 Practical Value of Effect . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
8.6 Equity Cost of a 1-Year Company . . . . . . . . . . . . . . . . . . . . . . .
8.7 Conclusions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

150
153
154
157
158

Inflation in Brusov–Filatova–Orekhova Theory and in Its
Perpetuity Limit Modigliani–Miller Theory . . . . . . . . . . . . . . . . .
9.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
9.2 Accounting of Inflation in the Modigliani–Miller Theory
Without Taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
9.3 Accounting of Inflation in Modigliani–Miller Theory
with Corporate Taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
9.4 Accounting of Inflation in Brusov–Filatova–Orekhova Theory
with Corporate Taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
9.4.1
Generalized Brusov–Filatova–Orekhova Theorem . . .

9.5 Generalized Brusov–Filatova–Orekhova Formula Under
Existence of Inflation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
9.6 Irregular Inflation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
9.7 Inflation Rate for a Few Periods . . . . . . . . . . . . . . . . . . . . . . . .
9.8 Conclusions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

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169
176
177
178
179

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183
183

183
185
186
188
191
193

Part II
10

11

148

. 161
. 161
. 162
. 166
. 168
. 168

Investments

A Portfolio of Two Securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
10.1 A Portfolio of Two Securities . . . . . . . . . . . . . . . . . . . . . . . .
10.1.1
A Case of Complete Correlation . . . . . . . . . . . . . . .
10.1.2
Case of Complete Anticorrelation . . . . . . . . . . . . . .
10.1.3

Independent Securities . . . . . . . . . . . . . . . . . . . . . .
10.1.4
Three Independent Securities . . . . . . . . . . . . . . . . . .
10.2 Risk-Free Security . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
10.3 Portfolio of a Given Yield (or Given Risk) . . . . . . . . . . . . . . .
10.3.1
Case of Complete Correlation (ρ12 ¼ 1)
and Complete Anticorrelation (ρ12 ¼ À1) . . . . . . . .
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

. 194
. 195

Investment Models with Debt Repayment at the End of the Project
and Their Application . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
11.1 Investment Models . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
11.2 The Effectiveness of the Investment Project
from the Perspective of the Equity Holders Only . . . . . . . . . . . .
11.2.1
With the Division of Credit and Investment Flows . . .

197
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198
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11.3
11.4

Without Flows Separation . . . . . . . . . . . . . . . . . . . . . . . . . . .
Modigliani–Miller Limit (Perpetuity Projects) . . . . . . . . . . . . .
11.4.1
With Flows Separation . . . . . . . . . . . . . . . . . . . . . .
11.4.2
Without Flows Separation . . . . . . . . . . . . . . . . . . . .
11.5 The Effectiveness of the Investment Project
from the Perspective of the Owners of Equity and Debt . . . . . .
11.5.1
With Flows Separation . . . . . . . . . . . . . . . . . . . . . .
11.5.2
Without Flows Separation . . . . . . . . . . . . . . . . . . . .
11.6 Modigliani–Miller Limit . . . . . . . . . . . . . . . . . . . . . . . . . . . .
11.6.1
With Flows Separation . . . . . . . . . . . . . . . . . . . . . .
11.6.2
Without Flows Separation . . . . . . . . . . . . . . . . . . . .
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
12

13

Influence of Debt Financing on the Efficiency of Investment
Projects: The Analysis of Efficiency of Investment Projects
Within the Perpetuity (Modigliani–Miller) Approximation . . . . . .
12.1 The Effectiveness of the Investment Project

from the Perspective of the Equity Holders Only . . . . . . . . . . .
12.1.1
With the Division of Credit and Investment Flows . .
12.1.2
Without Flows Separation . . . . . . . . . . . . . . . . . . . .
12.2 The Effectiveness of the Investment Project
from the Perspective of the Equity and Debt Owners . . . . . . . .
12.2.1
With the Division of Credit and Investment Flows . .
12.2.2
Without Flows Separation . . . . . . . . . . . . . . . . . . . .
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
The Analysis of the Exploration of Efficiency of Investment
Projects of Arbitrary Duration (Within Brusov–Filatova–
Orekhova Theory) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
13.1 The Effectiveness of the Investment Project
from the Perspective of the Equity Holders Only . . . . . . . . . . .
13.1.1
With the Division of Credit and Investment Flows . .
13.1.2
Without Flow Separation . . . . . . . . . . . . . . . . . . . .
13.2 The Effectiveness of the Investment Project
from the Perspective of the Owners of Equity and Debt . . . . . .
13.2.1
With the Division of Credit and Investment Flows . .
13.2.2
Without Flow Separation . . . . . . . . . . . . . . . . . . . .
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 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

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241

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. 273
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Contents

14

Investment Models with Uniform Debt Repayment and Their
Application . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
14.1 Investment Models with Uniform Debt Repayment . . . . . . . . .
14.2 The Effectiveness of the Investment Project
from the Perspective of the Equity Holders Only . . . . . . . . . . .
14.2.1
With the Division of Credit and Investment Flows . .
14.2.2
Without Flows Separation . . . . . . . . . . . . . . . . . . . .
14.3 The Effectiveness of the Investment Project
from the Perspective of the Owners of Equity and Debt . . . . . .
14.3.1
With Flows Separation . . . . . . . . . . . . . . . . . . . . . .
14.3.2
Without Flows Separation . . . . . . . . . . . . . . . . . . . .
14.4 Example of the Application of the Derived Formulas . . . . . . . .
14.5 Conclusions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Part III
15

16

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281
281
282
283
284

Taxation

Is It Possible to Increase Taxing and Conserve a Good Investment
Climate in the Country? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
15.1 Influence of Tax on Profit Rates on the Efficiency
of the Investment Projects . . . . . . . . . . . . . . . . . . . . . . . . . . . .
15.2 Investment Models . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
15.3 Borrowings Abroad . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
15.4 Dependence of NPV on Tax on Profit Rate at Different
Leverage Levels . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
15.5 At a Constant Value of Equity Capital (S ¼ Const) . . . . . . . . . .

15.6 Without Flow Separation . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
15.6.1
At a Constant Value of the Total Invested Capital
(I ¼ Const) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
15.6.2
At a Constant Value of Equity Capital (S ¼ Const) . . . .
15.7 Conclusions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
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 . . . . . . . . . . . . .
16.1 Dependence of NPV on Leverage Level L at Fixed Levels
of Tax on Profit Rate t . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
16.1.1
The Effectiveness of the Investment Project
from the Perspective of the Equity Holders Only . . .
16.1.2
The Effectiveness of the Investment Project
from the Perspective of the Equity and Debt
Holders . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

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292
293
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Contents

16.2

Dependence of NPV on Tax on Profit Rate at Fixed Leverage
Levels L . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
16.2.1
The Effectiveness of the Investment Project
from the Perspective of the Equity Holders Only . . .
16.2.2
The Effectiveness of the Investment Project
from the Perspective of the Equity and Debt
Holders . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
17

18


Optimizing the Investment Structure of the Telecommunication
Sector Company . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
17.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
17.2 Investment Analysis and Recommendations for
Telecommunication Company “Nastcom Plus” . . . . . . . . . . . .
17.2.1
The Dependence of NPV on Investment Capital
Structure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
17.2.2
The Dependence of NPV on the Equity Capital
Value and Coefficient β . . . . . . . . . . . . . . . . . . . . .
17.3 Effects of Taxation on the Optimal Capital Structure
of Companies in the Telecommunication Sector . . . . . . . . . . .
17.4 Conclusions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
The Golden Age of the Company (Three Colors
of Company’s Time) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
18.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
18.2 Dependence of WACC on the Age of the Company n
at Different Leverage Levels . . . . . . . . . . . . . . . . . . . . . . . . .
18.3 Dependence of WACC on the Age of the Company n
at Different Values of Capital Costs (Equity, k0, and Debt, kd)
and Fixed Leverage Levels . . . . . . . . . . . . . . . . . . . . . . . . . .
18.4 Dependence of WACC on the Age of the Company n
at Different Values of Debt Capital Cost, kd, and Fixed Equity
Cost, k0, and Fixed Leverage Levels . . . . . . . . . . . . . . . . . . . .
18.5 Dependence of WACC on the Age of the Company n
at Different Values of Equity Cost, k0, and Fixed Debt
Capital Cost, kd, and Fixed Leverage Levels . . . . . . . . . . . . . .
18.6 Dependence of WACC on the Age of the Company n at High

Values of Capital Cost (Equity, k0, and Debt, kd) and High
Lifetime of the Company . . . . . . . . . . . . . . . . . . . . . . . . . . . .
18.7 Further Investigation of Effect . . . . . . . . . . . . . . . . . . . . . . . .
18.8 Conclusions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

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389
391
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Contents

19

20

A “Golden Age” of the Companies: Conditions of Its Existence . . .
19.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
19.2 Companies Without the “Golden Age” (Large Difference
Between k0 and kd Costs) . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
19.2.1
Dependence of the Weighted Average Cost
of Capital, WACC, on the Company Age n
at Different Leverage Levels . . . . . . . . . . . . . . . . . . .
19.3 Companies with the “Golden Age” (Small Difference
Between k0 and kd Costs) . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
19.4 Companies with Abnormal “Golden Age” (Intermediate
Difference Between k0 and kd Costs) . . . . . . . . . . . . . . . . . . . .
19.5 Comparing with Results from Previous Chapter . . . . . . . . . . . .
19.5.1

Under Change of the Debt Capital Cost, kd . . . . . . . . .
19.5.2
Under Change of the Equity Capital Cost, k0 . . . . . . .
19.6 Conclusions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
The Role of the Central Bank and Commercial Banks
in Creating and Maintaining a Favorable Investment Climate
in the Country . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
20.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
20.2 Investment Models with Debt Repayment at the End
of the Project . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
20.2.1
The Effectiveness of the Investment Project
from the Perspective of the Equity Holders Only
(Without Flow Separation) . . . . . . . . . . . . . . . . . . . .
20.3 Modigliani–Miller Limit (Long-Term (Perpetuity) Projects) . . . .
20.3.1
The Dependence of the Efficiency of Investments
NPV on the Level of Debt Financing L for the Values
of Equity Costs k0 ¼ 0.2 . . . . . . . . . . . . . . . . . . . . . .
20.3.2
The Dependence of the Efficiency of Investments
NPV on the Level of Debt Financing L for the Value
of Equity Costs k0 ¼ 0.28 . . . . . . . . . . . . . . . . . . . . .
20.4 Projects of Finite (Arbitrary) Duration . . . . . . . . . . . . . . . . . . .
20.4.1
The Dependence of the Efficiency of Investments
NPV on the Level of Debt Financing L for the Values
of Equity Costs k0 ¼ 0.2 . . . . . . . . . . . . . . . . . . . . . .
20.4.2

The Dependence of the Efficiency of Investments
NPV on the Level of Debt Financing L for the Values
of Equity Costs k0 ¼ 0.28 . . . . . . . . . . . . . . . . . . . . .
20.5 The Dependence of the Net Present Value, NPV,
on the Leverage Level l for Projects of Different Durations . . . .
20.6 Conclusions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

xix

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396
397

397
399
403
410
410
411
411
414

415
415
416

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424

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Part IV
21

22

Ratings and Rating Methodologies

Rating: New Approach . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
21.1
Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
21.2
The Closeness of the Rating Agencies . . . . . . . . . . . . . . . . . .
21.3

The Use of Discounting in the Rating . . . . . . . . . . . . . . . . . . .
21.4
Incorporation of Parameters, Used in Ratings,
into Perpetuity Limit of Modern Theory of Capital Structure
by Brusov–Filatova–Orekhova . . . . . . . . . . . . . . . . . . . . . . . .
21.5
Models . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
21.5.1 One-Period Model . . . . . . . . . . . . . . . . . . . . . . . . .
21.5.2 Multi-period Model . . . . . . . . . . . . . . . . . . . . . . . .
21.6
Theory of Incorporation of Parameters, Used in Ratings,
into Perpetuity Limit of Modern Theory of Capital Structure
by Brusov–Filatova–Orekhova . . . . . . . . . . . . . . . . . . . . . . . .
21.6.1 Coverage Ratios . . . . . . . . . . . . . . . . . . . . . . . . . . .
21.6.2 More Detailed Consideration . . . . . . . . . . . . . . . . . .
21.6.3 Leverage Ratios . . . . . . . . . . . . . . . . . . . . . . . . . . .
21.7
Equity Cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
21.8
How to Evaluate the Discount Rate? . . . . . . . . . . . . . . . . . . . .
21.8.1 Using One Ratio . . . . . . . . . . . . . . . . . . . . . . . . . . .
21.8.2 Using a Few Ratios . . . . . . . . . . . . . . . . . . . . . . . . .
21.9
Influence of Leverage Level . . . . . . . . . . . . . . . . . . . . . . . . . .
21.9.1 The Dependence of Equity Cost ke on Leverage
Level at Two Coverage Ratio Values ij ¼ 1
and ij ¼ 2 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
21.10 The Dependence of Equity Cost ke on Leverage Level
at Two Leverage Ratio Values lj ¼ 1 and lj ¼ 2 . . . . . . . . . . .
21.11 Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Rating Methodology: New Look and New Horizons . . . . . . . . . . .
22.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
22.2 The Analysis of Methodological and Systemic Deficiencies
in the Existing Credit Rating of Nonfinancial Issuers . . . . . . . .
22.2.1
The Closeness of the Rating Agencies . . . . . . . . . . .
22.2.2
Discounting . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
22.2.3
Dividend Policy of the Company . . . . . . . . . . . . . . .
22.2.4
Leverage Level . . . . . . . . . . . . . . . . . . . . . . . . . . .
22.2.5
Taxation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
22.2.6
Account of the Industrial Specifics of the Issuer . . . .
22.2.7
Neglect of Taking into Account the Particularities
of the Issuer . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
22.2.8
Financial Ratios . . . . . . . . . . . . . . . . . . . . . . . . . . .

441
441
442
442

443
443

444
444

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445
448
450
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465
465
465

465
468
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473

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Contents

Modification of the BFO Theory for Companies
and Corporations of Arbitrary Age for Purposes of Ranking . . .
22.4 Coverage Ratios . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
22.4.1
Coverage Ratios of Debt . . . . . . . . . . . . . . . . . . . . .
22.4.2
The Coverage Ratio on Interest on the Credit . . . . . .
22.4.3
Coverage Ratios of Debt and Interest on the Credit
(New Ratios) . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
22.4.4
All Three Coverage Ratios Together . . . . . . . . . . . .
22.5 Coverage Ratios (Different Capital Cost Values) . . . . . . . . . . .
22.5.1
Coverage Ratios of Debt . . . . . . . . . . . . . . . . . . . . .
22.5.2
The Coverage Ratio on Interest on the Credit . . . . . .
22.5.3

Coverage Ratios of Debt and Interest on the Credit
(New Ratios) . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
22.5.4
Analysis and Conclusions . . . . . . . . . . . . . . . . . . . .
22.6 Leverage Ratios . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
22.6.1
Leverage Ratios for Debt . . . . . . . . . . . . . . . . . . . .
22.6.2
Leverage Ratios for Interest on Credit . . . . . . . . . . .
22.7 Leverage Ratios (Different Capital Costs) . . . . . . . . . . . . . . . .
22.7.1
Leverage Ratios for Debt . . . . . . . . . . . . . . . . . . . .
22.7.2
Leverage Ratios for Interests on Credit . . . . . . . . . .
22.7.3
Leverage Ratios for Debt and Interests on Credit . . .
22.7.4
Analysis and Conclusions . . . . . . . . . . . . . . . . . . . .
22.8 Conclusions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

xxi

22.3

23

Ratings of Long-Term Projects: A New Approach . . . . . . . . . . . .
23.1 Investment Models . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
23.1.1

The Effectiveness of the Investment Project
from the Perspective of the Equity Holders Only
(Without Flows Separation) . . . . . . . . . . . . . . . . . . .
23.1.2
Modigliani–Miller Limit [Long-Term (Perpetuity)
Projects] . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
23.2 Incorporation of Financial Coefficients, Used in Project Rating,
into Modern Investment Models . . . . . . . . . . . . . . . . . . . . . . .
23.2.1
Coverage Ratios . . . . . . . . . . . . . . . . . . . . . . . . . . .
23.2.2
Leverage Ratios . . . . . . . . . . . . . . . . . . . . . . . . . . .
23.3 Dependence of NPV on Coverage Ratios . . . . . . . . . . . . . . . .
23.3.1
Coverage Ratio on Debt . . . . . . . . . . . . . . . . . . . . .
23.4 Dependence of NPV on Leverage Ratios . . . . . . . . . . . . . . . .
23.4.1
Leverage Ratio of Debt . . . . . . . . . . . . . . . . . . . . . .
23.5 Conclusions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

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482
483
483


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487
490
490
492

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495
496
496

498
499
499
500
500
500
509
509

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. 512

. 512
. 513
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514
516
517
517
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522
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535


xxii

24

25

Contents

New Meaningful Effects in Modern Capital Structure Theory . . . .
24.1
Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
24.2
Comparison of Modigliani–Miller (MM)
and Brusov–Filatova–Orekhova (BFO) Results . . . . . . . . . . . .
24.2.1 The Traditional Approach . . . . . . . . . . . . . . . . . . . .
24.2.2 Modigliani–Miller Theory . . . . . . . . . . . . . . . . . . . .
24.3
Comparison of Modigliani–Miller Results (Perpetuity
Company) with Myers Results (1-Year Company)
and Brusov–Filatova–Orekhova Ones (Company
of Arbitrary Age) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
24.4
Bankruptcy of the Famous Trade-Off Theory . . . . . . . . . . . . .
24.5
The Qualitatively New Effect in Corporate Finance . . . . . . . . .

24.5.1 Perpetuity Modigliani–Miller Limit . . . . . . . . . . . . .
24.5.2 BFO Theory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
24.6
Conclusions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
24.7
Mechanism of Formation of the Company Optimal Capital
Structure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
24.8
“A Golden Age” of the Company . . . . . . . . . . . . . . . . . . . . . .
24.9
Inflation in Modigliani–Miller and BFO Theories . . . . . . . . . .
24.10 Effects, Connected with Tax Shields, Taxes, and Leverage . . .
24.11 Effects, Connected with the Influence of Tax on Profit Rate
on Effectiveness of Investment Projects . . . . . . . . . . . . . . . . .
24.12 Influence of Growth of Tax on Profit Rate . . . . . . . . . . . . . . .
24.13 New Approach to Ratings . . . . . . . . . . . . . . . . . . . . . . . . . . .
24.13.1 New Approach to Ratings: The Creditworthiness
of the Non-Finance Issuers . . . . . . . . . . . . . . . . . . .
24.13.2 New Approach to Long-Term Project Ratings . . . . .
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

537
537
539
539
540

542
544
546

548
549
550
551
554
557
560
561
561
564
564
566
567

Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 569
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 570


About the Authors

Petr Nickitovich Brusov is professor at the Financial University under the Government of the Russian Federation (Moscow). Originally a physicist,
he was the cofounder of (together with Victor
Popov) the theory of collective properties of superfluids and superconductors. In the areas of finance
and economy, Peter Brusov has created a modern
theory of capital cost and capital structure, the
Brusov—Filatova—Orekhova theory, together
with Tatiana Filatova and Natali Orekhova. Peter
Brusov has been visiting Professor of Northwestern
University (USA), Cornell University (USA), and
Osaka City University (Japan), among other places.

He is the author of over 500 research publications,
including six monographs, numerous textbooks,
and articles.

Tatiana Filatova is professor at the Financial University under the Government of the Russian Federation (Moscow). In the last 20 years, she has been
a dean of the faculties of financial management,
management, and state and municipal government,
among others, at the Financial University. Tatiana
Filatova is the author of over 250 research publications, including five monographs, numerous textbooks, and articles.

xxiii


xxiv

About the Authors

Natali Orekhova is professor of the Center of
Corporate Finance, Investment, Taxation and Rating at the Research Consortium of Universities of
the South of Russia. Natali Orekhova has been
leading scientist of the Financial University under
the Government of the Russian Federation. She is
the author of over 100 research publications,
including three monographs, numerous textbooks,
and articles.

Mukhadin Abdurakhmanovich Eskindarov is
professor, honored scholar of the Russian Federation, member of the Russian Academy of Education,
and rector of the Financial University under the
Government of the Russian Federation (Moscow).

Mukhadin A. Eskindarov has played crucial administrative, teaching, and researcher roles at the Financial University. He is the author of over 200 research
publications, including monographs, manuals, and
articles on issues related to labor and production
efficiency, financial and industrial groups, economic
development of the third-world countries, and modernization of the educational system. As a member of
various state and public administration bodies,
Mukhadin A. Eskindarov has been honored with
highly recognized state and public awards, including
the IV Class Order for Merit to the Fatherland, Order
of Friendship, Petr Stolypin II Class Medal, badge of
the Honored Worker of the Higher Education System of the Russian Federation, and Patriot of Russia
Medal, among others.


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 Modigliani
and Miller (MM) (Modigliani and Miller 1958, 1963, 1966), not only do not solve

the problem but also because of the large number of restrictions (such as, e.g., 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,
taxation, and ratings is laid. It is based on the author’s 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 Brusov–
Filatova–Orekhova (BFO theory) (Brusov and Filatova 2011; Brusov et al. 2011a,
b, c, 2012a, b, 2013a, b, 2014a, b, 2015, 2018a, b, c, d; Filatova et al. 2008, Brusova
2011). The authors have moved from the assumption of Modigliani–Miller
concerning the perpetuity of companies (infinite time of life of companies) and
further elaborated quantitative theory of valuation of core parameters of financial
activities of companies of arbitrary age or arbitrary time of life.
Results of modern BFO theory (Brusov and Filatova 2011; Brusov et al. 2011a, b, c,
2012a, b, 2013a, b, 2014a, b, 2015, 2018a, b, c, d; Filatova et al. 2008; Brusova
2011) turn out to be quite different from that of Modigliani–Miller theory (Modigliani and Miller 1958, 1963, 1966). They show that the latter, via its perpetuity,
underestimates (often significantly) 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 and the company using the debt financing.

© Springer Nature Switzerland AG 2018
P. Brusov et al., Modern Corporate Finance, Investments, Taxation and Ratings,
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1 Introduction


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 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 company’s dividend policy (modern principles of
which are formulated in monograph). Authors take into account in explicit form the
inflation in both Modigliani–Miller as well as Brusov–Filatova–Orekhova 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, 2015, 2018a, b, c, d; 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 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 activities
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 agencies, using
incorrect MM theory. This reason is now understood by the US Government, which
requires $1 billion from rating agency S&P for overvalued capitalization of mortgage companies.
Within Brusov–Filatova–Orekhova 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 tradeoff theory, the question of finding a new mechanism of the formation of the
company’s 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 Modigliani–Miller theory (Modigliani and Miller 1958, 1963, 1966),
even in modified version, developed by us, and exists within more general BFO
theory.