Textbook Notes (367,977)
Canada (161,540)
Finance (37)
MGFC10H3 (13)
Derek Chau (13)
Chapter 18

Chapter 18 Notes

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Derek Chau

Chapter 18 Valuation and Capital Budgeting for the Levered Firm Notes181 Adjusted Present Value APV Approachadjusted present value APV method is best described by the following formula APVNPVNPVFadjusted present value APVbase case NPV of a projects operating cash flows plus present value of any financing benefitsthere are 4 major side effects1The tax subsidy to debt For perpetual debt the value of the tax subsidy is TB T is the corporate tax rate and B is the CCvalue of the debt The material on valuation under corporate taxes is actually an application of the APV approach2The costs of financial distress The possibility of financial distress and bankruptcy is particular arises with debt financing Financial distress imposes costs thereby lowering value3The costs of issuing new securities Investment bankers participate in the public issuance of corporate debt These bankers must be compensated for their time and effort a cost that lowers the value of the project4Subsidies to debt financing The interest rate on debt issued by the provinces and the federal government is substantially below the yield on debt issued by risky private corporations Frequently corporations are able to obtain loan guarantees from government lowering their borrowing costs to a government rate This subsidy adds valuewhile each of these 4 side effects is important the tax deduction to debt almost certainly has the highest dollar value in practice182 Flow to Equity FTE Approachthe flow to equity FTE approach is an alternative capital budgeting approachthe formula simply calls for discounting the cash flow from the project to the equity holders of the levered firm at rSfor a perpetuity this becomescash flow from project to equity holders of the levered firmrSlevered cash flow can be calculated directly from unlevered cash flow UCFthe key here is that the difference between the cash flow that equity holders receive in an unlevered firm and the cash flow that equity holders receive in a levered firm is the aftertax interest paymentthis can be written asUCFLCF1T rBwhere LCF is the cash flow to the levered equity holdersCBto calculate the discount rate rrrBS 1T rrSS0C0Bthe present value of the projects LCF is LCFrSthe NPV of the
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