IDEAS home Printed from https://ideas.repec.org/p/col/000463/002734.html
   My bibliography  Save this paper

For finite cash flows, what is the correct formula for the return to levered equity?

Author

Listed:
  • Joseph Tham
  • Ignacio Vélez-Pareja

Abstract

For cash flows in perpetuity without growth, analysts typically use the following formula for the return to levered equity Ke. Ke = Ku + (Ku – Kd) (1 – T)D/E (1) where Ku is the return to unlevered equity, Kd is the cost of debt, T is the tax rate, D is the market value of debt and E is the market value of equity. What is the corresponding formula for finite cash flows? Is it the same as equation 1? In other words, is equation 1 appropriate for both finite and infinite cash flows? One may be tempted to believe that equation 1 is the general formulation for the return to levered equity and applies to both cash flows in perpetuity and finite cash flows. However, this conclusion is misleading. In this short note, using simple algebra, we derive the general formulation for the return to levered equity for finite cash flows, and show that equation 1 is not the general formulation for finite cash flows.

Suggested Citation

  • Joseph Tham & Ignacio Vélez-Pareja, 2004. "For finite cash flows, what is the correct formula for the return to levered equity?," Proyecciones Financieras y Valoración 2734, Master Consultores.
    • Handle: RePEc:col:000463:002734
    as

    Download full text from publisher

    File URL: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=545122
    Download Restriction: no
    ---><---

    More about this item

    Keywords

    Present value of the tax shield; cost of levered equity;

    JEL classification:

    • D61 - Microeconomics - - Welfare Economics - - - Allocative Efficiency; Cost-Benefit Analysis
    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
    • H41 - Public Economics - - Publicly Provided Goods - - - Public Goods

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:col:000463:002734. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    We have no bibliographic references for this item. You can help adding them by using this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Ignacio Velez (email available below). General contact details of provider: .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.