Chapter17ValuationandCapitalBudgetingfortheLeveredFirm1Chapter17ExecutiveSummaryFinancingandInvestmentdecisionsareactuallyrelated.Aprojectofanall-equityfirmmightberejected,whilethesameprojectmightbeacceptedforaleveredbutotherwiseidenticalfirm.Previouslyweassumethatthefirmisfinancedwithequityonly.Thegoalofthischapteristovalueaproject,orthefirmitself,whenleverageisemployed.2Chapter17ExecutiveSummaryThreestandardapproachestovaluationunderleverage:APV(adjusted-present-value)FTE(flow-to-equity)WACC(weighted-average-cost-of-capital)3Chapter1717.1Adjusted-Present-ValueApproachAPV=NPV+NPVFAPV:adjustedpresentvalueNPV:valueoftheprojecttoanunleveredfirmNPVF:netpresentvalueofthefinancingsideeffects.4Chapter1717.1Adjusted-Present-ValueApproachOnecangenerallythinkoffoursideeffectsTheTaxSubsidytoDebtTheCostsofIssuingNewSecuritiesThecostsofFinancialDistressSubsidiestoDebtFinancingWeconsiderthetaxsubsidyonlyinthefollowingexample.ExampleOne(page469)5Chapter1717.1Adjusted-Present-ValueApproachConclusionfromtheexample:Thevalueoftheprojectwhenfinancedwithsomeleverageisequaltothevalueoftheprojectwhenfinancedwithallequityplusthetaxshieldfromthedebt.6Chapter1717.2Flow-To-EquityApproachTheFlow-to-Equityapproachisanalternativecapitalbudgetingapproach.Thefomulasimplycallsfordiscountingthecashflowfromtheprojecttotheequityholdersoftheleveredfirmatthecostofequitycapital,rs.7Chapter1717.2Flow-To-EquityApproachTherearethreestepstotheFTEapproachStep1:CalculatingLeveredCashFlow(LCF)Step2:CalculatingrsStep3:Valuation8Chapter1717.3Weighted-Average-Cost-of-CapitalMethod9Chapter1717.4AComparisonoftheAPV,FTE,andWACCApproachesCapitalbudgetingtechniquesintheearlychaptersofthistextappliedtoall-equityfirms.Capitalbudgetingfortheleveredfirmcouldnotbehandledearlyinthebookbecausetheeffectsofdebtonfirmvalueweredeferreduntiltheprevioustwochapters.10Chapter1717.4AComparisonoftheAPV,FTE,andWACCApproachesDebtincreasesfirmvaluethroughtaxbenefitsbutdecreasesvaluethroughbankruptcyandrelatedcosts.APVfirstvaluestheprojectonanall-equitybasis,andthenaddthenetpresentvalueofthedebt.11Chapter1717.4AComparisonoftheAPV,FTE,andWACCApproachesTheFTEapproachdiscountstheafter-taxcashflowfromaprojectgoingtotheequityholdersofaleveredfirm(LCF).Thediscountrateisrs,whichshowsthatleverageraisestherisktotheequityholders.12Chapter1717.4AComparisonoftheAPV,FTE,andWACCApproachesAllthreeapproachesperformthesametask:valuationinthepresenceofdebtfinancing,allthreeprovidethesamevaluationestimate.Thethreeapproachesaremarkedlydifferentintechnique.13Chapter1717.4AComparisonoftheAPV,FTE,andWACCApproachesComparison:APVversusWACCAPVandWACCdisplaythegreatestsimilarity.Bothapproachesputtheunleveredcashflow(UCF)inthenumerator.However,theAPVdiscountsatr0,theWACCdiscountsatrWACC.BothapproachesadjustthebasicNPVformulaforunleveredfirmsinordertoreflectthetaxbenefitofleverage.14Chapter1717.4AComparisonoftheAPV,FTE,andWACCApproachesComparison:EntityBeingValued.TheFTEapproachappearsatfirstglancetobefardifferentfromtheothertwo.FortheFTE,onlythefirm’scontributiontotheinitialinvestmentissubtractedout.UnderFTE,onlythefuturecashflowstotheleveredequityholdersarevalued.15Chapter1717.4AComparisonoftheAPV,FTE,andWACCApproachesAsuggestedGuidelineNPVofprojectisexactlythesameundereachofthethreemethods.However,onemethodusuallyprovidesaneasiercomputationthananother,and,inmanycases,oneormoreofthemethodsarevirtuallyimpossiblecomputationally.16Chapter1717.4AComparisonoftheAPV,FTE,andWACCApproachesASuggestedGuidelineUseWACCorFTEifthefirm’stargetdebt-to-valueratioappliestotheprojectoveritslife.UseAPViftheproject’slevelofdebtisknownoverthelifeoftheproject.17Chapter1717.5CapitalBudgetingWhenTheDiscountRateMustBeEstimatedTheprevioussectionsofthischapterintroducedAPV,FTE,andWACC—thethreebasicapproachestovaluingaleveredfirm.Oneimportantdetailremains,weassumedadiscountrate.Wenowwanttoshowhowthisrateisdeterminedforreal-worldfirmswithleverage.18Chapter1717.6APVExampleIffirmssetatargetdebt-to-equityratio,weuseWACCandFTEforcapitalbudgeting.However,aswementionedearlier,APVisthepreferredapproachwhentherearesidebenefitsandsidecoststodebt.Anexample,inadditiontothetaxsubsidytodebt,bothflotationcostsandinterestsubsidiescomeintoplay.19Chapter1717.7BetaandLeverageChapter12(page318)providestheformulafortherelationshipbetweenthebetaofthecommonstockandleverageofthefirminaworldwithouttaxes.Formula17.3Thisrelationshipholdsundertheassumptionthatthebetaofdebtiszero.20Chapter1717.邪7B貼eta任an富dL拳eve臭rag亦eThe征corp牢orat匯e-ta邀xca遙se.余Form卷ula承17.4償.It花can滑be窩se葛en逼tha肉tl孝eve選era成ge附inc哀rea宵ses栗th粥ee采qui羊ty蔬bet徑al坑ess寄ra降pid伐ly慌und企er竭cor濫por乳ate托ta份xes抄.This鋼occ蔑urs若beca班use,醒und織ert新axes暴,le桌vera糾gec塘reat紀(jì)esa雕ris石kles軟sta攔xsh貿(mào)ield挎,th陸ereb