Lecture_20 - 2-1Lecture 20Chapter 18:Valuation and Capital...

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Unformatted text preview: 2-1Lecture 20Chapter 18:Valuation and Capital Budgeting for the Levered Firm2-2Valuing projects with leverageWhat is the effects of leverage on the value created by a projectWe can apply:Adjusted Present Value ApproachFlows to Equity ApproachWeighted Average Cost of Capital Method2-3Adjusted Present Value ApproachAPV = NPV + NPVFThe value of a project to the firm is the value of the project to an unlevered firm (NPV) plus the present value of the financing side effects (NPVF).There are four side effects of financing:The Tax Subsidy to DebtThe Costs of Issuing New SecuritiesThe Costs of Financial DistressSubsidies to Debt Financing2-4APV Example123 4$1,000$125$250$375$50050.56$)10.1(500$)10.1(375$)10.1(250$)10.1(125$000,1$%10432%10-=++++-=NPVNPVThe unlevered cost of equity is R= 10%:The project would be rejected by an all-equity firm: NPV< 0.Consider a finite life project with the incremental after-tax cash flows for an all-equity firm:2-5APV ExampleIf the firm finances the project with $600of =+-=41)08.1(20.19$50.56$ttAPV09.7$59.6350.56$=+-=APVSo, the firm should accept the project with debt.2-6Flow to Equity ApproachDiscount the cash flow from the project to the equity holders of the levered firm at the cost of levered equity capital, RS.2-7Step One: Levered Cash Flows...
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This note was uploaded on 07/04/2011 for the course FINA 463 taught by Professor Tsyplakov during the Fall '10 term at South Carolina.

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Lecture_20 - 2-1Lecture 20Chapter 18:Valuation and Capital...

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