In a world with corporate taxes a firms weighted

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In a world with corporate taxes, a firm’s weighted average cost of capital equals:RWACC= [B/ (B+ S)](1 –tC)RB+ [S/ (B+ S)]RSSo we need the debt-value and equity-value ratios for the company. The debt-equity ratio for the company is:B/S= .35B= .35SExample29
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09/10/20196Question 1(c)So, using the capital structure weights, the company’s WACC is:RWACC= [B/ (B+ S)](1 –tC)RB+ [S/ (B+ S)]RSRWACC= .26(1 – .40)(.07) + .74(.1426)RWACC= .1165, or 11.65%Example31Question 1(c)We can use the weighted average cost of capital to discount the firm’s unlevered after tax earnings to value the company. Doing so, we find:VL= $4,200,000 / .1165VL= $36,045,772.41Example32Question 1(c)Now we can use the debt-value ratio and equity-value ratio to find the value of debt and equity, which are:B= $36,045,772.41(.26)B= $9,345,200.25S= $36,045,772.41(.74)S= $26,700,572.16Example33Question 1(d)Use the flow to equity method to calculate the value of equity.Example34Question 1(d)In order to value a firm’s equity using the flow-to-equity approach, we can discount the cash flows available to equity holders at the cost of the firm’s levered equity. First, we need to calculate the levered cash flows available to shareholders, which are: Example35Question 1(d)Example36Sales$17,500,000Variable costs10,500,000EBIT$7,000,000Interest654,164EBT$6,345,836Tax2,538,334Net income$3,807,502
09/10/20197Question 1(d)So, the value of equity with the flow-to-equity method is:S= Cash flows available to equity holders / RSS= $3,807,502 / .1426S= $26,700,572.16Example37Summary
Practice QuestionsQuestions 1 and 4 from your ebook page 31139Summary4Use the WACC or FTE if the firm's target debt to value ratio applies to the project over its life.WACC is the most commonly used by far.FTE has appeal for a firm deeply in debt.5The APV method is used if the level of debt is known over the project’s life.The APV method is frequently used for special situations like interest subsidies, LBOs, and leases.6The beta of the equity of the firm is positively related to the leverage of the firm.40Quick QuizExplain how leverage impacts the value created by a potential project.
Learning Objectives – Week 9Understand and be able to apply scenario and sensitivity analysisUnderstand the various forms of break-even analysisUnderstand Monte Carlo simulationUnderstand the importance of real options in capital budgetingUnderstand decision trees
Week 6DIVIDEND POLICY1Learning ObjectivesDefine dividend policy and explain why it is irrelevant to shareholders’ wealth in a perfect capital market with no taxes

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