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Lecture_20

# Lecture_20 - Lecture 20 Chapter 18 Valuation and Capital...

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2-1 Lecture 20 Chapter 18: Valuation and Capital Budgeting for the Levered Firm

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2-2 Valuing projects with leverage What is the effects of leverage on the value created by a project We can apply: Adjusted Present Value Approach Flows to Equity Approach Weighted Average Cost of Capital Method
2-3 Adjusted Present Value Approach APV = NPV + NPVF The 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 Debt The Costs of Issuing New Securities The Costs of Financial Distress Subsidies to Debt Financing

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2-4 APV Example 0 1 2 3 4 –\$1,000 \$125 \$250 \$375 \$500 50 . 56 \$ ) 10 . 1 ( 500 \$ ) 10 . 1 ( 375 \$ ) 10 . 1 ( 250 \$ ) 10 . 1 ( 125 \$ 000 , 1 \$ % 10 4 3 2 % 10 - = + + + + - = NPV NPV The unlevered cost of equity is R 0 = 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:
2-5 APV Example If the firm finances the project with \$ 600 of = + - = 4 1 ) 08 . 1 ( 20 . 19 \$ 50 . 56 \$ t t APV 09 . 7 \$ 59 . 63 50 . 56 \$ = + - = APV So, the firm should accept the project with debt .

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2-6 Flow to Equity Approach Discount the cash flow from the project to the equity holders of the levered firm at the cost of levered equity capital, R S .
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Lecture_20 - Lecture 20 Chapter 18 Valuation and Capital...

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