Chapter 17 - Valuation and capital budgeting for the levered

Chapter 17 - Valuation and capital budgeting for the...

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Chapter 17 Valuation and Capital Budgeting for the Levered Firm 17.1 Adjusted-Present-Value Approach (APV) APV = NPV + NPVF o Value of a project to a levered firm (APV) = Project of unlevered firm + NPV of financing side effects Side effects: 1. Tax subsidy to debt - for perpetual debt, value of tax subsidy is T C B 2. Cost of issuing new securities 3. Cost of financial distress 4. Subsidies to debt financing → Interest on debt issued by state/local government is not taxable to the investor (Subsidy adds value) Present value of a project is determined before initial investment at date 0 is subtracted →The initial investment is subtracted for the calculation of net present value Lend a fixed percentage of market value of a project not a fixed percentage of initial investment Net present value of project under leverage APV = NPV + T C * B 17.2 Flows-to-Equity Approach (FTE) r s = Cost of equity capital for perpetuity FTE = s r firm levered of ers equityhold project to from flow Cash Step 1: Calculating Levered Cash Flow (LCF) Cash inflow - Cash costs - Interest . Income after interest - Corporate Tax . Levered cash flow Alternatively o Difference between cash flow that equity holders receive in an unlevered firm and cash flow that equity holders receive in a levered firm is after-tax interest payment LCF = UCF - (1-T C )*r B* B Step 2: Calculating r s r S = r 0 + S B * (1 - T C ) * (r 0 - r B ) Step 3: Valuation Present value of LCF = s r LCF PV of project is simply difference between PV of project’s LCF and investment not borrowed (cash inflow – debt) PV project = LCF – (cash inflow – debt) 1
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Chapter 17 Valuation and Capital Budgeting for the Levered Firm 17.3 Weighted-Average-Cost-of-Capital Method (WACC) r WACC = B S S + * r s + B S B + *r B * (1-T c ) The target ratios are generally expressed in terms of market value. Discount unlevered cash flow of project at the weighted average cost of capital r
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Chapter 17 - Valuation and capital budgeting for the...

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