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Lect 14 221 web - Managerial Finance Lecture 14 Sealed Air...

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1 Managerial Finance Lecture 14 Sealed Air Class 13. Summary Debt financing affects value because it affects cash flows : Debt financing can increase the net-of-tax cash flows Reduce tax liabilities relative to an all-equity financed firm High levels of debt financing can decrease FCFs: direct and indirect costs of financial distress Trade-off theory of capital structure . Firms choose an optimal level of debt financing that balances: 1. The tax benefit of using debt financing against 2. The costs of financial distress Valuation methods to capture the effect of debt tax shields on firm value: 2 WACC : discount FCFs using the after-tax WACC Adjusted Present Value (APV). Two steps: 1. Value the project as if it were all-equity financed: FCFs and all-equity cost of capital (pre-tax) 2. Add the present value of the tax shield of debt: using the expected interest tax shield and the tax shield cost of capital
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