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Adjustment of the WACC with Subsidized Debt in the Presence of Corporate Taxes: the N-Period Case


  • Ignacio Velez-Pareja

    (Politecnico Garncolombiano)

  • Joseph Tham

    (Duke University)

  • Viviana Fernandez

    (Universidad de Chile)


In the Weighted Average Cost of Capital (WACC) applied to the free cash flow (FCF), we assume that the cost of debt is the market, unsubsidized rate. With debt at the market rate and perfect capital markets, debt only creates value in the presence of taxes through the tax shield. In some cases, the firm may be able to obtain a loan at a rate that is below the market rate. With subsidized debt and taxes, there would be a benefit to debt financing, and the unleveraged and leveraged values of the cash flows would be unequal. The benefit of lower tax savings are offset by the benefit of the subsidy. These two benefits have to be introduced explicitly. In this paper we present the adjustments to the WACC with subsidized debt and taxes and the cost of leveraged equity for multiple periods. We demonstrate the analysis for both the WACC applied to the FCF and the WACC applied to the capital cash flow (CCF). We use the calculation of the Adjusted Present Value, APV, to consider both, the tax savings and the subsidy. We show how all the methods match.

Suggested Citation

  • Ignacio Velez-Pareja & Joseph Tham & Viviana Fernandez, 2005. "Adjustment of the WACC with Subsidized Debt in the Presence of Corporate Taxes: the N-Period Case," Finance 0504006, University Library of Munich, Germany.
  • Handle: RePEc:wpa:wuwpfi:0504006
    Note: Type of Document - pdf; pages: 13

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    References listed on IDEAS

    1. Ignacio Velez-Pareja & Joseph Tham, 2005. "Proper Solution of Circularity in the Interactions of Corporate Financing and Investment Decisions: A Reply to the Financing Present Value A," Proyecciones Financieras y Valoración 003395, Master Consultores.
    2. Joseph Tham & Ignacio Velez-Pareja Velez-Pareja, 2005. "With Subsidized Debt How do we Adjust the WACC?," Proyecciones Financieras y Valoración 003783, Master Consultores.
    3. Ignacio Vélez-Pareja, 2004. "Modeling the Financial Impact of Regulatory Policy: Practical Recommendations and Suggestions. The Case of World Bank," Proyecciones Financieras y Valoración 003228, Master Consultores.
    4. Ignacio Vélez-Pareja, 2007. "Cash Flow Valuation in an Inflactionary World. The Case of World Bank for Regulated Firms," Economic Analysis Working Papers (2002-2010). Atlantic Review of Economics (2011-2016), Colexio de Economistas de A Coruña, Spain and Fundación Una Galicia Moderna, vol. 6, pages 1-19, November.
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    More about this item


    Adjusted Present Value; APV; weighted average cost of capital; discounted cash flow; DCF equity value; cost of equity; WACC; subsidized debt with taxes; valuation of cash flows; project evaluation; project appraisal; firm valuation; cost of capital; cash flows; free cash flow; capital cash flow;

    JEL classification:

    • D61 - Microeconomics - - Welfare Economics - - - Allocative Efficiency; Cost-Benefit Analysis
    • G30 - Financial Economics - - Corporate Finance and Governance - - - General
    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • H43 - Public Economics - - Publicly Provided Goods - - - Project Evaluation; Social Discount Rate

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