Topic 7 WACC and FCF to Equity

Question 1

WACC Valuation

Answer 1

Adjusts the discount rate to reflect effects of the tax shield on value of the firm
-requires: constant risk in future, constant leverage ratio
*note - calculated using net debt

Question 2

Steps of WACC valuation

Answer 2

1. Find unlevered cost of capital of twin firm -> solve for rU
2. estimate the new cost of debt at new leverage and recalculate the cost of equity with leverage -> rE with rU +(D/e)*delta rU-rD
3. Calculate WACC at new leverage and do NPV

Question 3

FCFE

Answer 3

Free cash flow to equity
-cash flow that may be available for distribution to equity holders
-> Take FCF then decrease by after-tax interest expense and increase by net borrowings
*assumptions- cost of equity is constant, constant debt to equity ratio -> would change the cost of equity

Question 4

APV

Answer 4

Adjusted Present Value
-good if there is a significant change in leverage over time
-directly incorporates tax effect into the value of the firm/project
-use a firms unlevered cost of capital to discount then use that value back to your firm to use as the Value unlevered

Question 5

Debt outstanding at end of prior year

Answer 5

D(t-1) used to find value of interest tax shield at time t Interest year t = rD(D(t-1)) thus
*Interest tax shided in year t = rD(D(t-1)Tc

Question 6

Interest paid at time t

Answer 6

= k(FCFt)

Question 7

Tax shield at time t

Answer 7

Tck(FCFt)

Question 8

k

Answer 8

constant percentage of free cash flows, constant interest coverage