Lecture19_winter09

# Lecture19_winter09 - VALUATION AND CAPITAL BUDGETING FOR...

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VALUATION AND CAPITAL BUDGETING FOR THE LEVERED FIRM

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VALUATION AND CAPITAL BUDGETING FOR THE LEVERED FIRM Last lecture we saw that there were three methods to calculate the present value of projects (or firms) when they are financed in part by debt APV Method WACC Method FTE Method We will make an example with each and show they give the same result
APV In this method, the project is treated as if a all equity financing approach was taken. The project will use the Cash Flows without considering the interest payments The Cash Flows will be discounted using the cost of capital for a all-equity firm Only at the end, the present value of the tax shield will be considered and added up

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APV The Cash flows are called UNLEVERED CASH FLOWS   N t t t R UCF NPV 1 0 1 Investment - Debt of Effects PV
APV EXAMPLE Consider a project of P. B. Singer Co. with the following characteristics Initial Investment: \$475,000 Sales: \$500,000 as a perpetuity Cost of Sales: 72% of Sales Corporate Tax: 34% R 0 =20%

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APV EXAMPLE The project is going to be financed partly with Debt. The Firm will issue bonds with a Market Value of \$126,229.5 So, out of the \$475,000 total investment, \$126,229.5 is financed with Debt and \$348,770.5 with Equity
APV EXAMPLE The Unlevered Cash Flows are the following Sales \$500,000 Cost of Sales -\$360,000 Operating Income \$140,000 Taxes -\$47,600 Unlevered Cash Flow \$92,400

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APV So, the Net Present Value for the all-equity project is So, an all-equity Financing decision would have meant that you don’t want to do the project.
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## Lecture19_winter09 - VALUATION AND CAPITAL BUDGETING FOR...

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