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Valuation with Changing Capital Structure

Valuation with Changing Capital Structure. Arzac, Chapter 6 . Leverage Changes. increase in debt ratio affects value value increases by extra value of interest tax shield value decreases due to increase in cost of equity due to risk increasing

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Valuation with Changing Capital Structure

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  1. Valuation with Changing Capital Structure Arzac, Chapter 6

  2. Leverage Changes • increase in debt ratio affects value • value increases by extra value of interest tax shield • value decreases due to increase in cost of equity due to risk increasing • relatively constant debt ratio implies use of WACC to discount FCFs • use different valuation method if debt ratio changes (especially large changes in ratio)

  3. Adjusted Present Value • Myers (1974) • value two components: • unlevered FCFs discounted at the after-personal tax cost of capital of unlevered firm • tax shield discounted at the after-personal tax cost of debt • AdvPak example • plan to spin off to shareholders with $20million of debt which gradually increases to target debt ratio of 35% (Exhibit shows planned debt increases)

  4. Problem 6.2 • Obtain the original APV of TPI Inc. using the data of Problem 2.7, and compare your result to that obtained using WACC in the solution to Problem 2.7. Project interest expenses on the basis of the EBIT coverage ratio. For continuous value, use the enterprise value calculated with WACC for a 26% debt ratio. Unlever beta using equation 3.17.

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