Unformatted text preview: Capital
Obtaining
Cost MM proposition II with taxes B
rS = r0 + (1 − T )( r0 − rB )
S This gives the following unlevering formula for the all
equity cost of capital r0 = S
B
rS +
(1 − T )rB
S + B (1 − T )
S + B (1 − T ) What happens with riskfree debt? 31 AllEquity Cost of Capital vs. WACC
AllEquity Cost Note that, although this looks very similar to the formula for WACC, they are slightly different: WACC can be shown to be (we did this on p. 13): S + B(1 − T )
WACC =
* r0
S+B This corresponds with our intuition that WACC falls as the debt to equity ratio increases Again, we carefully discussed this issue on p. 1213. 32 Obtaining the AllEquity β
Obtaining We will refer to the “allequity beta”, “unlevered beta” or “asset beta” indistinctly, and will denote it βA. B (1 − T ) S
βA = β E + S + B(1 − T ) β D S + B(1 − T ) When we assume the debt beta = 0, we get:
B β E = 1 + (1 − T ) β A
S Where are these things coming from?
33 APV APPLICATIONS: Example 3 Suppose a firm is considering a $30 million project that will last for five years (assume no depreciation here). Projected after tax operating cash flows are $9 million per year during the life of the project. The tax rate is 40%. The unlevered cost of capital is r0=20% (the cost of capital to a similar allequity firm). Suppose the firm is deciding between either all equity financing or financing with a fiveyear balloon payment loan of $22.5 million before flotation costs. The interest rate...
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 Spring '13
 Net Present Value, APV

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