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Lecture5 - ucf apv fte debt wacc

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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 All-Equity Cost of Capital vs. WACC All-Equity 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 All-Equity 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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