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Adjusted Present Value Approach Corporate Valuation Learning Outcomes Appraise with the calculation of Enterprise value through Adjusted present Value Approach of Corporate Valuation. Differentiate between DCF and APV Approach of Valuation Brainstrom • 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). • The third with the optimal balance amongst two. • Adjusted Present Value Approach • – – – – Example Consider a project of the Pearson Company, the timing and size of the incremental after-tax cash flows for an all- equity firm are: • -$1,000 $125 $250 $375 $500 • 0 1 2 3 4 • The unlevered cost of equity is r0 = 10%: Example (Cont) Calculate EV of Riviera Using Adjusted Present Value Approach millions Years 1 2 3 4 5 Free Cash Flow 200 250 300 340 380 Firm • Beyond Year5, the free cash flow to the firm of Riviera will grow at a constant rate of 10% pa • Riviera unlevered cost of equity is 14 Percent. • Riviera Debt-Equity ratio of 4:7 • The risk-free rate of interest is 8 percent Interest Bearing Debt Interest Expense 500 400 300 200 100 60 48 36 24 12 • Cost of borrowing is 12 Percent • Tax rate is 30 Percent • Market risk Premium is 6 percent Problem • Unlevered beta and effective tax rate of S Ltd is 0.8 and 35 percent respectively. The company intends to undertake a project with 60 percent debt financing. Assuming risk free rate of 7.5 % and market premium 8 %, calculate cost of equity (rounded up to two decimal points) • (A) 13.90% • (B) 20.14% • (C) 16.40% • (D) None of (A), (B) or (C)

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