di-0451-e

According to myers vts pvd kd t kd 6 miles and ezzell

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Unformatted text preview: shields discounted at the required return on debt (Kd). According to Myers, VTS = PV[D Kd T ; Kd]. 6) Miles and Ezzell (1980). This theory states that the correct rate for discounting the tax shield (D Kd T) is Kd for the first year, and Ku for the following years. 7) Miller (1977) concludes that the leverage-driven value creation or value of the tax shields is zero. 8) With-cost-of leverage. This theory assumes that the cost of leverage is the present value of the interest differential that the company pays over the risk-free rate. 9) Modigliani and Miller (1963) calculate the value of tax shields by discounting the present value of the tax savings due to interest payments of a risk-free debt (T D RF) at the risk-free rate (RF). Modigliani and Miller claim that: VTS = PV[RF; DT RF] Appendix 1 gives a brief overview of the most significant theories on discounted cash flow valuation. Appendix 2 contains the valuation equations according to these theories. Appendix 3 shows how the valuation equations change if the debt’s market value is not equal to its nominal value. Appendix 4 contains a list of the abbreviations used in the paper. 1. Ten Discounted Cash Flow Methods for Valuing Companies There are four basic methods for valuing companies by discounted cash flows: Method 1. Using the free cash flow and the WACC (weighted average cost of capital). 2 - IESE Business School-University of Navarra Equation [1] indicates that the value of the debt (D) plus that of the shareholders’ equity (E) is the present value of the expected free cash flows (FCF) that the company will generate, discounted at the weighted average cost of debt and shareholders’ equity after tax (WACC): [1] E0 + D0 = PV0 [WACCt ; FCFt] The definition of WACC or “weighted average cost of capital” is given by [2]: [2] WACCt = [Et-1 Ket + Dt-1 Kdt (1-T)] / [Et-1 + Dt-1] Ke is the required return on equity, Kd is the cost of the debt, and T is the effective tax rate applied to earnings. Et-1 + Dt-1 are market values. In actual fact, “market values” a...
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This note was uploaded on 05/10/2013 for the course MBA MBA taught by Professor Mba during the Fall '11 term at ESLSCA.

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