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Unformatted text preview: debt: – PVF = Σ (Interest Expense t x TC )/ (1+ rB)t – Or PVF = (rB x B x TC)/rB = TC x B for a perpetuity 18 Financing Side Effect Costs of financial distress, debt financing subsidies, and issuance costs can all be incorporated into the financing side effects Note: the value of a project with leverage is greater than the value without leverage (financing side effect). Same thing we got for WACC. 19 WACC vs. APV Note that the WACC method required us to use the firm’s target capital structure, while APV does not. APV requires us to forecast the annual interest expense (and thus the annual debt level) while WACC does not. 20 Back to Example 2: APV Valuation Cash sales: $500,000 forever
Cash costs: 72% of sales; Corporate tax rate (TC): 34%; Cost of capital if unlevered (r0): 20%; Interest Rate (rB): 10%; Target B/S = 1/3 (thus B=1, S=3, and B+S=4)
Also Recall that UCF = $92,400 per year.
The present value of the unlevered company is: PVU = $92,400 / 0.2 = $462,000 21 Back to Example 2: APV Valuation The NPV of Singer’s acquisition if the buyer were required to maintain an all equity capital structure would be: NPVU = $475,000 + $462,000 = $13,000. So we would not purchase Singer. Now calculate the financing side effect, which is the present value of Singer’s perpetual debt tax shields: PVF = (B x rB x TC) / rB = TC x B TC we know, but what is B?
22 Back to Example 2: APV Valuation Finding B is a little bit tricky in this problem, since we want to reconcile our the results of our methods
We want 1/4 of the levered firm’s value (VL) to be financed by debt because target B/E=1/3, so
B = .25 x VL We also know from the APV rule that VL = PVU + TCB Solving B = $126,229.50 and so PVF = $42,918 Then, APV = $504,918 and NPV = $29,918 23 Flows to Equity (FTE) FTE values only the equity portion of a firm or project. We need to value the cash flow to the firm’s equity holders (after paying interest to debt holders). Thus, we need to use the levered cash flows (LCF)
Discount the levered cash flows at the required rate of return on the levered equity (rS), which is: rS = r...
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 Spring '13

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