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1、McGraw-Hill/IrwinCopyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.17-1Corporate Finance Ross Westerfield JaffeSixth EditionSixth Edition17Chapter Seventeen Capital Budgeting for the Levered FirmMcGraw-Hill/IrwinCopyright 2002 by The McGraw-Hill Companies, Inc. All rights reserve
2、d.17-2 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.McGraw-H
3、ill/IrwinCopyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.17-3 Chapter Outline17.1 Adjusted Present Value Approach17.2 Flows to Equity Approach17.3 Weighted Average Cost of Capital Method17.4 A Comparison of the APV, FTE, and WACC Approaches17.5 Capital Budgeting When the Discou
4、nt Rate Must Be Estimated17.6 APV Example17.7 Beta and Leverage17.8 Summary and ConclusionsMcGraw-Hill/IrwinCopyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.17-4 17.1 Adjusted Present Value Approach The value of a project to the firm can be thought of as the value of the project
5、 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 FinancingMcGraw-Hill/IrwinCopyright 2002 by The McGraw-Hill
6、 Companies, Inc. All rights reserved.17-5 APV ExampleConsider a project of the Pearson Company, the timing and size of the incremental after-tax cash flows for an all- equity firm are:01 2 3 4-$1,000$125 $250 $375 $500The unlevered cost of equity is r0 = 10%:The project would be rejected by an all-e
7、quity firm: NPV 0.McGraw-Hill/IrwinCopyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.17-6 APV Example (continued) Now, imagine that the firm finances the project with $600 of debt at rB = 8%. Pearsons tax rate is 40%, so they have an interest tax shield worth TCBrB = .40$600.08 =
8、 $19.20 each year. The net present value of the project under leverage is:So, Pearson should accept the project with debt.McGraw-Hill/IrwinCopyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.17-7 APV Example (continued) Note that there are two ways to calculate the NPV of the loan.
9、 Previously, we calculated the PV of the interest tax shields. Now, lets calculate the actual NPV of the loan:Which is the same answer as before.McGraw-Hill/IrwinCopyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.17-8 17.2 Flows to Equity Approach Discount the cash flow from the p
10、roject 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.McGraw-Hill/IrwinCopyright 2002 by The McGra
11、w-Hill Companies, Inc. All rights reserved.17-9 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, CF0 = -$400 Each period, the equity holders must pay interest expense. The after-tax cost of t
12、he interest is BrB(1-TC) = $600.08(1-.40) = $28.80 01 2 3 4-$400$221.20CF2 = $250 -28.80$346.20CF3 = $375 -28.80-$128.80 CF4 = $500 -28.80 -600CF1 = $125-28.80$96.20McGraw-Hill/IrwinCopyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.17-10 Step Two: Calculate rS for Pearson To calc
13、ulate the debt to equity ratio, B/S, start with the debt to value ratio. Note that the value of the project isB = $600 when V = $1,007.09 so S = $407.09. McGraw-Hill/IrwinCopyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.17-11 Step Three: Valuation for Pearson Discount the cash f
14、lows to equity holders at rS = 11.77% 01 2 3 4-$400 $96.20 $221.20 $346.20 -$128.80 McGraw-Hill/IrwinCopyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.17-12 17.3 WACC Method for Pearson To find the value of the project, discount the unlevered cash flows at the weighted average co
15、st of capital. Suppose Pearson Inc. target debt to equity ratio is 1.50McGraw-Hill/IrwinCopyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.17-13 Valuation for Pearson using WACC To find the value of the project, discount the unlevered cash flows at the weighted average cost of capitalMcGraw-Hill/IrwinCopyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.17-1417.4 A Comparison of the APV, FTE, and WACC Approaches All three approaches attempt the same task:valuation in the presence of debt financing. Guidelines:
