Valuation and capital budgeting for the levered firm

Valuation and capital budgeting for the levered firm -...

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Click to edit Master subtitle style 10/2/11 Valuation and capital budgeting for the levered 11

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10/2/11 Adjusted present value approach (APV) The value of a project to a levered firm (APV) is equal to the value of the project to an unlevered firm (NPV) plus the NPV of the financing side effects (NPVF) APV = NPV + NPVF Side effects Interest tax shields: PV of tax shields is TCD, where TC is the tax rate and D is 22
10/2/11 APV: an example A firm is considering a project with the following characteristics: Sales = \$500,000 per year for indefinite future Costs = 72% of sales Initial investment = \$440,000 TC = 40%, and rA = 20%, (cost of capital for an all- equity firm) 33

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10/2/11 APV: An example Suppose that the firm finances the project with exactly \$116,666.67 in debt, so the remaining investment of \$323,333.33 is financed with equity. Ø The NPV of the project under leverage APV = NPV +TCD = -20,000 +40%*116,666,67 = 26,666.67 44
10/2/11 Flow to equity approach (FTE) The formula simply calls for discounting the cash flows from the project to equityholders of the levered firm at the cost of equity capital rE.

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This note was uploaded on 10/02/2011 for the course ECON 101 taught by Professor Mikson during the Spring '08 term at Aarhus Universitet.

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Valuation and capital budgeting for the levered firm -...

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