Download Adjusted Present Value Approach

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
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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)