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There exists circularity between WACC and value? Another solution


  • Ignacio Vélez-Pareja,


  • Julián Benavides-Franco



Although we know there exists a simpleapproach to solve the circularitybetween value and the discount rate,known as the Adjusted Present Valueproposed by Myers, 1974, it seemsthat practitioners still rely on thetraditional Weighted Average Cost ofCapital, WACC approach of weightingthe cost of debt, Kd and the costof equity, Ke and discounting the FreeCash Flow, FCF. We show how to solvecircularity when calculating valuewith the free cash flow, FCF and theWACC. As a result of the solution wearrive at a known solution when weassume the discount rate of the tax savings as Ke, the cost of unleveredequity: the capital cash flow, CCF discountedat Ku. When assuming Kdas the discount rate for the tax savings,we find an expression for calculatingvalue that does not impliescircularity. We do this for a singleperiod and for N periods.

Suggested Citation

  • Ignacio Vélez-Pareja, & Julián Benavides-Franco, 2006. "There exists circularity between WACC and value? Another solution," ESTUDIOS GERENCIALES, UNIVERSIDAD ICESI, March.
  • Handle: RePEc:col:000129:003998

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    Cited by:

    1. Ignacio Vélez-Pareja, 2009. "Which Cost Of Debt Should Be Used In Forecasting Cash Flows?," ESTUDIOS GERENCIALES, UNIVERSIDAD ICESI, June.

    More about this item


    Firm valuation; cost of capital; cashflows; free cash flow; capital cash flow; WACC; circularity;

    JEL classification:

    • M21 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Business Economics - - - Business Economics
    • M40 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting - - - General
    • M41 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting - - - Accounting
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
    • J33 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - Compensation Packages; Payment Methods


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