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E the beta of the debt is zero however we think that

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Unformatted text preview: ven risk of the assets (ßu), by using equation [30] we obtain a higher ßL (and consequently a higher Ke and a lower equity value) than with equation [22]. Equation [30] appears in many finance books and is used by some consultants and investment banks. Although Damodaran does not mention what the value of tax shields should be, his equation [30] relating the levered beta to the asset beta implies that the value of tax shields is: [31] VTS = PV[Ku; D T Ku - D (Kd- RF) (1-T)] Another way of calculating the levered beta with respect to the asset beta is the following: [32] ßL = ßu (1+ D/E) We will call this method the Practitioners’ method, because consultants and investment banks often use it (one of the many places where it appears is Ruback (1995, page 5)). It is obvious that according to this equation, given the same value for ßu, a higher ßL (and a higher Ke and a lower equity value) is obtained than according to [22] and [30]. Notice that equation [32] is equal to equation [30] eliminating the (1-T) term. We interpret equation [32] as an attempt to introduce still higher leverage costs into the valuation; for a given risk of the assets (ßu), by using equation [32] we obtain a higher ßL (and consequently a higher Ke and a lower equity value) than with equation [30]. Equation [32] relating the levered beta with the asset beta implies that the value of tax shields is: [33] VTS = PV[Ku; D T Kd - D(Kd- RF)] By comparing [33] to [31] it can be seen that [33] provides a VTS that is PV[Ku; D T (Ku- RF)] lower than [31]. We interpret this difference as additional leverage cost (on top of the leverage cost of Damodaran) introduced in the valuation. Inselbag and Kaufold (1997) argue that if the firm targets the dollar values of debt outstanding, the VTS is given by the Myers (1974) equation. However, if the firm targets a constant debt/value ratio, the VTS is given by the Miles and Ezzell (1980) equation. Copeland, Koller and Murrin (2000) deal with the adjusted present value in their Appendix A. They only mention perpetuities and only propose two wa...
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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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