Week 5

Question 1

APV (Adjusted Present Value):

Answer 1

Takes into account NPV of a project and also adds the present value of financing for a project.

APV = NPV +NPFV

Possible financing side effects:
1) Tax subsidy to debt
2) Costs of issuing new securities (such as payments to bankers)
3) Costs of financial distress
4) Subsidies to debt financing (can acquire financing from the municipality at the tax-exempt rate)

Question 2

Flow to equity approach (FTE):

Answer 2

Discounts the cash flow from the project to shareholders of the levered firm at the cost of equity

PV = CF to equity holders (LCF)/R(E)

1) Calculate LCF
2) Calculate R(E)
3) Value the project
NPV = PV of LCF - amount not borrowed

Question 3

WACC method:

Answer 3

WACC is used when:
1)Analysis is snapshot (done in a single period)
2) When analyzing multiple periods, with a constant D/E ratio
3) Firms in a steady state, either on purpose (leverage ratio), or involuntarily (issuing debt or equity is costly)

NPV = -initial investment + UCF/1+WACC

UCF = EBIT * (1-Tc)

The main issue however is that it is unknown whether the value arrives from financing effects or the base net present value.

Question 4

Which method to use

Answer 4

When the debt-to-value ratio is known and applied over the project’s life use FTE and WACC.
APV is used when debt levels are known and can change. APV is also used in special cases such as leveraged buyouts, interest subsidies, and floatation costs.

Question 5

What if the discount rate is unknown:

Answer 5

Entering a new business a company can look at the competitors to determine discount rates.
R(E) for competitor can be determined as beta can be found of publicly traded companies.

After that R(a) can be computed and it is assumed that R(a) is similar for the competitors therefore it can be applied to our company.

Question 6

Beta and leverage:

Answer 6

In a world without taxes:
B(equity) = B(assets) * (1+debt/equity)

In a world with taxes:

B(equity) = (1+((1-tc)*debt/equity) * B(unlevered firm)

Question 7

Net Asset Value:

Answer 7

Is used when project is dependent on limited resources which at some point will run out. Usually used in industry as mining.