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Finanças

Finanças. Nov 30. Topics covered. Capital budgeting with debt Adjusted Present Value Approach Flows to Equity Approach Weighted Average Cost of Capital Method. Adjusted Present Value Approach. The value of a project to the firm can be thought of as side effects of financing :.

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Finanças

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  1. Finanças Nov 30 QDai for FEUNL

  2. Topics covered • Capital budgeting with debt • Adjusted Present Value Approach • Flows to Equity Approach • Weighted Average Cost of Capital Method QDai for FEUNL

  3. Adjusted Present Value Approach • The value of a project to the firm can be thought of as • side effects of financing: QDai for FEUNL

  4. APV Example Consider a project of the Pearson Company, the timing and size of the incremental after-tax cash flows for an all-equity firm are: –$1,000 $125 $250 $375 $500 0 1 2 3 4 The unlevered cost of equity is r0 = 10%: QDai for FEUNL

  5. APV Example (continued) • Now, imagine that the firm finances the project with $600 of debt at rB = 8%. • Pearson’s tax rate is 40% The net present value of the project under leverage is: QDai for FEUNL

  6. APV Example (continued) • Another way to calculate the NPV of the loan. • Previously, we calculated the PV of the interest tax shields. Now, let’s calculate the actual NPV of the loan: QDai for FEUNL

  7. Flows to Equity Approach • Discount the cash flow from the project to _________________________________ at the cost of _________________________ • Three steps in the FTE Approach QDai for FEUNL

  8. Step One: Levered Cash Flows for Pearson • Since the firm is using $600 of debt, the equity holders only have to come up with • Thus, CF0 = • Each period, the equity holders must pay interest expense. QDai for FEUNL

  9. B B To calculate the debt to equity ratio, , start with S V Step Two: Calculate rS for Pearson QDai for FEUNL

  10. Step Three: Valuation for Pearson • Discount the cash flows to equity holders at rS = 11.77% QDai for FEUNL

  11. WACC Method for Pearson • To find the value of the project, discount ___________________________________ at ____________________________________ • Suppose Pearson’s target debt to equity ratio is 1.50 QDai for FEUNL

  12. Valuation for Pearson using WACC • To find the value of the project, discount the unlevered cash flows at the weighted average cost of capital QDai for FEUNL

  13. A Comparison of the APV, FTE and WACC • All three approaches attempt the same task: • Guidelines: • Use WACC or FTE if • Use the APV if • In the real world QDai for FEUNL

  14. Summary: APV, FTE, and WACC APV WACC FTE Initial Investment Cash Flows Discount Rates PV of financing effects Which approach is best? • Use APV • Use WACC and FTE when • the most common • for a highly levered firm QDai for FEUNL

  15. Estimating the discount rate • Firm A wants to finance a new project with a B/S ratio of 1/3. Its borrowing rate is 10%. • Firm B in the same industry has a B/S ratio of 2/3. The beta of its equity is 1.5. Firm B’s borrowing rate is 12%. • Corporate tax rate = 40%. • Market risk premium = 8.5% • Rf = 8% • What is the discount rate for Firm A’s new project? QDai for FEUNL

  16. Estimating the discount rate • Firm B’s cost of equity • Firm B’s cost of capital if unlevered QDai for FEUNL

  17. Estimating the discount rate QDai for FEUNL

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