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WACC and free cash flows: A simple adjustment for capitalized interest costs

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  • Pierru, Axel
  • Babusiaux, Denis
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    Abstract

    This paper shows how to value investment projects involving capitalization of interest costs by using the standard WACC method. Whenever capitalized interest costs do not immediately generate proportionate tax shields, one of the assumptions that justify the use of the after-tax weighted average cost-of-capital formula is violated. As an offset to this violation, the project's free cash flows have to be adjusted. We here derive and interpret a simple adjustment formula. A numerical illustration is provided.

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    Bibliographic Info

    Article provided by Elsevier in its journal The Quarterly Review of Economics and Finance.

    Volume (Year): 50 (2010)
    Issue (Month): 2 (May)
    Pages: 240-243

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    Handle: RePEc:eee:quaeco:v:50:y:2010:i:2:p:240-243

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    Web page: http://www.elsevier.com/locate/inca/620167

    Related research

    Keywords: Capitalized interest WACC APV Interest tax shield Capitalization;

    References

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    Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
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    1. Robert A. Taggart & Jr., 1991. "Consistent valuation and Cost of Capital Expressions With Corporate and Personal Taxes," Financial Management, Financial Management Association, vol. 20(3), Fall.
    2. Richard S Ruback, 2002. "Capital Cash Flows: A Simple Approach to Valuing Risky Cash Flows," Financial Management, Financial Management Association, vol. 31(2), Summer.
    3. Miles, James A & Ezzell, John R, 1985. " Reformulating Tax Shield Valuation: A Note," Journal of Finance, American Finance Association, vol. 40(5), pages 1485-92, December.
    4. Bowen, Robert M. & Noreen, Eric W. & Lacey, John M., 1981. "Determinants of the corporate decision to capitalize interest," Journal of Accounting and Economics, Elsevier, vol. 3(2), pages 151-179, August.
    5. Miles, James A. & Ezzell, John R., 1980. "The Weighted Average Cost of Capital, Perfect Capital Markets, and Project Life: A Clarification," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 15(03), pages 719-730, September.
    6. 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.
    7. Graham, John R. & Harvey, Campbell R., 2001. "The theory and practice of corporate finance: evidence from the field," Journal of Financial Economics, Elsevier, vol. 60(2-3), pages 187-243, May.
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    Cited by:
    1. Keef, Stephen P & Khaled, Mohammed S & Roush, Melvin L, 2011. "Miller's (2009) WACC model: An extension," Working Paper Series 1995, Victoria University of Wellington, School of Economics and Finance.

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