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Two Dcf Approaches For Valuing Companies Under Alternative Financing Strategies (And How To Choose Between Them)

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  • Isik Inselbag
  • Howard Kaufold
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    Abstract

    This is the sequel to the authors' 1989 article discussing the two basic discounted cash flow approaches for valuing debt-financed transactions and corporations: weighted average cost of capital (WACC) and adjusted present value (APV). The WACC method discounts all after-tax (but pre-interest) cash flows at the company's weighted average cost of capital. The APV method treats the value of a levered firm as the value of the same firm if financed entirely with equity plus the discounted value of the interest tax shields from the debt its assets will support. The authors argue that the WACC approach is more practical if the firm intends to hold its (market) leverage ratio relatively constant over time, but that the APV technique is the preferred method if the firm plans to reduce its leverage ratio according to a pre-determined schedule (as tends to be the case in highly leveraged transactions). 1997 Morgan Stanley.

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    Bibliographic Info

    Article provided by Morgan Stanley in its journal Journal of Applied Corporate Finance.

    Volume (Year): 10 (1997)
    Issue (Month): 1 ()
    Pages: 114-122

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    Handle: RePEc:bla:jacrfn:v:10:y:1997:i:1:p:114-122

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    Cited by:
    1. Groh, Alexander P. & Henseleit, Christoph, 2009. "The valuation of tax shields induced by asset step-ups in corporate acquisitions," IESE Research Papers D/785, IESE Business School.
    2. Fernandez, Pablo, 2007. "A more realistic valuation: APV and WACC with constant book leverage ratio," IESE Research Papers D/715, IESE Business School.
    3. Fernandez, Pablo, 2004. "Value of tax shields and the risk of the net increase of debt, The. Year 2004," IESE Research Papers D/544, IESE Business School.
    4. Fernandez, Pablo, 2005. "Financial literature about discounted cash flow valuation," IESE Research Papers D/606, IESE Business School.
    5. Fernandez, Pablo, 2003. "Equivalence of ten different methods for valuing companies by cash flow discounting," IESE Research Papers D/524, IESE Business School.
    6. Pierru, Axel & Roussanaly, Simon & Sabathier, Jérôme, 2013. "Capital structure in LNG infrastructures and gas pipelines projects: Empirical evidences and methodological issues," Energy Policy, Elsevier, vol. 61(C), pages 285-291.
    7. Fernandez, Pablo, 2004. "The value of tax shields is NOT equal to the present value of tax shields," Journal of Financial Economics, Elsevier, vol. 73(1), pages 145-165, July.
    8. Fernandez, Pablo, 2004. "Equivalence of ten different discounted cash flow valuation methods," IESE Research Papers D/549, IESE Business School.
    9. Fernandez, Pablo, 2006. "A general formula for the WACC: A correction," IESE Research Papers D/663, IESE Business School.
    10. Pierru, Axel, 2009. ""The weighted average cost of capital is not quite right": A rejoinder," The Quarterly Review of Economics and Finance, Elsevier, vol. 49(4), pages 1481-1484, November.
    11. Fernández , Pablo, 2002. "Valuing companies by cash flow discounting: Ten methods and nine theories," IESE Research Papers D/451, IESE Business School.

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