# chap017 - Chapter 17 VALUATION AND CAPITAL BUDGETING FOR...

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Chapter 17 VALUATION AND CAPITAL BUDGETING FOR THE LEVERED FIRM SLIDES CHAPTER ORGANIZATION 17.1 Adjusted Present Value Approach 17.2 Flow to Equity Approach Step 1: Calculating Levered Cash Flow (LCF) Step 2: Calculating R s Step 3: Valuation 17.3 Weighted Average Cost of Capital Method 17.1 Key Concepts and Skills 17.2 Chapter Outline 17.3 Adjusted Present Value Approach 17.4 APV Example 17.5 APV Example 17.6 Flow to Equity Approach 17.7 Step One: Levered Cash Flows 17.8 Step One: Levered Cash Flows 17.9 Step Two: Calculate R S 17.10 Step Three: Valuation 17.11 WACC Method 17.12 WACC Method 17.13 WACC Method 17.14 A Comparison of the APV, FTE, and WACC Approaches 17.15 Summary: APV, FTE, and WACC 17.16 Summary: APV, FTE, and WACC 17.17 Capital Budgeting When the Discount Rate Must Be Estimated 17.18 Beta and Leverage 17.19 Beta and Leverage: No Corporate Taxes 17.20 Beta and Leverage: With Corporate Taxes 17.21 Beta and Leverage: With Corporate Taxes 17.22 Summary 17.23 Summary 17.24 Quick Quiz

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A-205 CHAPTER 17 17.4 A Comparison of the APV, FTE, and WACC Approaches A Suggested Guideline 17.5 Capital Budgeting When the Discount Rate Must Be Estimated 17.6 APV Example 17.7 Beta and Leverage The Project Is Not Scale-Enhancing ANNOTATED CHAPTER OUTLINE Slide 17.0 Chapter 17 Title Slide Slide 17.1 Key Concepts and Skills Slide 17.2 Chapter Outline 17.1. Adjusted Present Value Approach Slide 17.3 Adjusted Present Value Approach The Adjusted-Present-Value (APV) for a project with debt financing is: APV = NPV U + NPVF. APV has the conceptual advantage of separating the value of the unlevered investment from the value of financing side-effects. NPV is the net present value of the project to an all-equity firm: NPV = PV UCF – Initial investment for entire project PV UCF : PV of Unlevered Cash Flows (UCF) UCF = CF from oper. – Capital Spending – Added NWC Discount rate: R 0 (Unlevered cost of capital) NPVF is the net present value of financial side effects, which include: tax subsidy to debt the costs of issuing new debt and equity securities the costs of financial distress arising from the use of debt subsidies to debt financing Students have already seen one of these side-effects: the tax shield from debt in MM's Proposition I, V L = V U + t C B.
CHAPTER 17 A-206 Slide 17.4 – Slide 17.5 APV Example An Example of APV and the Tax Subsidy to Debt Since students are familiar with the Modigliani-Miller assumptions, our example takes advantage of the simplicity in the MM world. Suppose PMM, Inc. has an investment that costs \$10,000,000 with expected EBIT (cash flows from operations) of \$3,030,303 per year forever. The investment can be financed either with \$10,000,000 in equity or with \$5,000,000 of 10% debt and \$5,000,000 of internally generated (equity) cash flows. The discount rate on an all-equity-financed project in this risk class is 20%. The firm's marginal tax rate is 34%. 1. All-equity value

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## chap017 - Chapter 17 VALUATION AND CAPITAL BUDGETING FOR...

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