Session 15: Valuation with Corporate Taxes

Question 0

Investment’s initial levered value

Answer 0

Vol=(FCF1/1+rWACC)+(FCF2/1+rWACC^2)+L

Question 1

3 methods of valuation

Answer 1

• WACC
• APV (adjusted PV)
• FTE (flow to equity)

Question 2

Constant D/E ratio: WACC method summary

Answer 2

1. Determine the FCF of the investment
2. Compute WACC
3. Compute the value of the investment, including the tax benefit of leverage, by discounting the FCF of investment using WACC

Question 3

Constant D/E-ratio: APV method

Answer 3

Vl=Vu+PV(interest TS)
1. Determine the unlevered Value of the firm by discounting the FCF at the unlevered costs of cap. rU or pre-tax WACC
2. Compute the PV of the interest TS
interest paid in year t=rDxD(t-1)
PV of the TS is the interest TS discounting by rU
3. Finally, compute the levered value for the project
Vl=Vu+PV(interest TS)

Question 4

APV method summary

Answer 4

1. Determine the investment’s value without leverage
2. Determine the PV of the interest TS
   a) expected interest TS
   b) discount interest TS
3. Add the unlevered value to the PV of the interest TS to determine the value of the investment with leverage

Question 5

Constant D/E-ratio: FTE method

Answer 5

1. Calculate the FCFE which can be obtained by adjusting the FCF
   FCFE(t)=NI(t)+Depr(t)-CapEx(t)-Increase in NWC (t)+Net borrowing,
   wobei Net borrowing at date t = D(t)-D(t-1)
2. The PV of FCFE is discounted by the equity cost of capital rE

Question 6

FTE method summary

Answer 6

1. Determine the FCFE of the investment
2. Determine the rE
3. Compute the equity value by discounting the FCFE using rE

Question 7

APV method: constant interest coverage ratio

Answer 7

Vl=Vu(1+Tcxk)

Question 8

APV method: predetermined debt levels

Answer 8

-when debt levels are set according to fixed schedule, we can discount the predetermined interest TS using the debt of cost of capital
- if debt had a predetermined level forever, we could actually get:
Vl=Vu+TcxD