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Unformatted text preview: 0 + (B/S)(1 TC)(r0 rB) 24 Flows to Equity (FTE) The value of the equity portion (PVE) of the firm / project is:
PVE = Σ LCFt / (1+rS) t For a perpetuity this becomes PVE = LCF/ rS Implementation takes three steps:
1)Calculate LCF 2)Calculate rS 3)Valuation using PVE formula 25 Back to Example 2: FTE Valuation Step 1: find the LCF
To compute interest payments, we need the B, which we calculated before: B = $126,229.50. Also recall rB = 10%
Cash inflows $500,000 Cash costs 360,000 Interest expense 12,622.95 Income after interest 127,377.05 Corporate Tax (.34) 43,308.20 Levered Cash Flow (LCF) $84,068.85 26 Back to Example 2: FTE Valuation Step 2: calculate rS. We previously calculated rS = 22.2% Step 3: compute PVE
The present value of the equity portion of Singer is:
PVE = 84,068.85 / .222 = $378,688.50 Note that total firm value is PV = PVE + B = $504,918 And that B is ¼ of firm value
27 Back to Example 2: FTE Valuation We now need to calculate the NPV of this equity investment in Singer’s acquisition
But careful: we must deduct only the part of the purchase price paid by equity This is because the rest (B=$126,229.50) was borrowed Thus, NPV = 348,770.50 + 378,688.50 = $29,918 28 Summary of the Methods All three methods are equivalent in principle, but in practice one of these methods will be easier to implement Both WACC and FTE implicitly assume that the market value debt/equity ratio is constant over time. If it changes, then we would have to adjust the discount rate over time, but it may get very complicated. As a general rule, when the D/E ratio is constant over time, WACC and FTE are easier to use. When debt ratios change in time, but you know the dollar amounts of debt over time, then APV is easier to use. 29 Implementation Details Use the following notation – r0: the allequity cost of capital – rS: the required return on levered equity – rB: the required return on debt – B: the market value of debt – S: the market value of equity β S: beta of the levered equity β A: beta for an unlevered firm
β D: beta for debt 30 Obtaining the All-Equity Cost of...
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This document was uploaded on 03/09/2014 for the course COMM 371 at UBC.
- Spring '13