Capital Budgeting for the Levered Firm参考.ppt

Prospectus Recall that there are three questions in corporate finance. The first regards what long-term investments the firm should make (the capital budgeting question). The second regards the use of debt (the capital structure question). This chapter is the nexus of these questions. Chapter Outline 17.1 Adjusted Present Value Approach 17.2 Flows to Equity Approach 17.3 Weighted Average Cost of Capital Method 17.4 A Comparison of the APV, FTE, and WACC Approaches 17.5 Capital Budgeting When the Discount Rate Must Be Estimated 17.6 APV Example 17.7 Beta and Leverage 17.8 Summary and Conclusions 17.1 Adjusted Present Value Approach The value of a project to the firm can be thought of as the value of the project to an unlevered firm (NPV) plus the present value of the financing side effects (NPVF): There are four side effects of financing: The Tax Subsidy to Debt The Costs of Issuing New Securities The Costs of Financial Distress Subsidies to Debt Financing 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: APV Example (continued) Now, imagine that the firm finances the project with $600 of debt at rB = 8%. Pearson’s tax rate is 40%, so they have an interest tax shield worth TCBrB = .40×$600×.08 = $19.20 each year. APV Example (continued) Note that there are two ways 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: 17.2 Flows to Equity Approach Discount the cash flow from the project to the equity holders of the levered firm at the cost of levered equity capital, rS. There are three steps in the FTE Approach: Step One: Calculate the levered cash flows Step Two: Calculate rS. Step Three: Valuation of the levered cash flows at rS. Step One: Levered Cash Flows for Pearson Since the firm is using $600 of debt, the equity holders only have to come up with $400 of the initial $1,000. Thus