A Research On The Impact Of Company's Financial Leverage To The Equity Valuation

It is believed that a company could choose its own way to use the resources. This option leads to the conclusion that the determinants of the stock market value depend on tow situations:when the expected benefits received is greater than the present value of its resources, the company will choose to continue its operation. At this time, the market value of the company's stock is equal to the present value of the company's expected future profits. As the current profits can be regarded as an alternative variable of the company's expectation of the future profits, therefore, the market value of the company's stock depends on the current value of the company's profits; and when expected benefits of continuing operation is less than the benefits that the company gains from changing the existing use of its resources, the company will change its current way of using the resources. At this time, the market value of the company's stock is equal to the opportunity cost of its resources, that is, the book value of the equity.Leverage level is another important factor impacting the market value of a company's stock. The theory of equity market timing believes that different companies face different market timing, companies with lower leverage tend to raise capital when their stocks'market value are higher, while, companies with higher leverage tend to raise capital when their stocks'market value are lower. The activity of raising capital influence the size of ownership, therefore, the leverage level will influence the investment, and then the relationship between the value of ownership and the beginning book value of ownership, and the relationship between the value of ownership and the current profits. Taking into account of this effect, analyzing those relationships will become even more complex:on the one hand, current scale of investment is impacted not only by the net profit of current period, but also by the market timing that company faces. Through influencing market timing, a single company's debt levels will change the relationship between its expected return and investment size, thus affecting the market value of ownership. On the other hand, as market timing is defined as the market value of equity divided the book value of equity, the market value of equity will in turn affect the company's market timing, then affect the company's investment and financing activities and finally the correlation between debt levels and net profits.This paper uses non-financial listed companies which issue the A shares in Shanghai and Shenzhen stock exchanges. We choose the data from the year of 2001 to the year of 2006. By empirical research, it is proved that:to companies with low level debt, the market value of equity is the increasing function of net profits, the lower the leverage levels are, the greater the multiples effect are. To those companies, the market value of equity is the increasing function of equity's book value however, there is no obvious regular pattern as the debt leverage decreases. To companies with high level debt, there is no obvious correlation between market value of equity and net profits and book value of equity.This research can be used in investment decision-making, operation and management evaluation, help to analysis and appraisal a company's performance in security markets, and contribute to the government policy-making.