VALORACION ECONOMICA DE EMPRESAS Manuel Carreño 2010 ®

Financing and Valuation Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved McGraw-Hill/Irwin

Capital Project Adjustments 1.Adjust the Discount Rate Modify the discount rate to reflect capital structure, bankruptcy risk, and other factors. 2.Adjust the Present Value Assume an all equity financed firm and then make adjustments to value based on financing.

After Tax WACC Tax Adjusted Formula

After Tax WACC Example - Sangria Corporation The firm has a marginal tax rate of 35%. The cost of equity is 12.4% and the pretax cost of debt is 6%. Given the book and market value balance sheets, what is the tax adjusted WACC?

After Tax WACC Example - Sangria Corporation - continued

After Tax WACC Example - Sangria Corporation - continued

After Tax WACC Example - Sangria Corporation - continued Debt ratio = (D/V) = 500/1,250 =.4 or 40% Equity ratio = (E/V) = 750/1,250 =.6 or 60%

After Tax WACC Example - Sangria Corporation - continued

After Tax WACC Example - Sangria Corporation - continued The company would like to invest in a perpetual crushing machine with cash flows of $1.731 million per year pre-tax. Given an initial investment of $12.5 million, what is the value of the machine?

After Tax WACC Example - Sangria Corporation - continued The company would like to invest in a perpetual crushing machine with cash flows of $1.731 million per year pre-tax. Given an initial investment of $12.5 million, what is the value of the machine?

After Tax WACC Example - Sangria Corporation - continued The company would like to invest in a perpetual crushing machine with cash flows of $1.731 million per year pre-tax. Given an initial investment of $12.5 million, what is the value of the machine?

After Tax WACC Example - Sangria Corporation – continued Perpetual Crusher project

After Tax WACC Example - Sangria Corporation – continued Perpetual Crusher project

After Tax WACC Example - Sangria Corporation – continued Perpetual Crusher project

Capital Budgeting Valuing a Business or Project The value of a business or Project is usually computed as the discounted value of FCF out to a valuation horizon (H). The valuation horizon is sometimes called the terminal value.

Capital Budgeting Valuing a Business or Project PV (free cash flows)PV (horizon value) In this case r = wacc

Valuing a Business Example: Rio Corporation

Valuing a Business Example: Rio Corporation – continued - assumptions

Valuing a Business Example: Rio Corporation – continued FCF = Profit after tax + depreciation + investment in fixed assets + investment in working capital FCF = – ( ) – ( ) = $3.5 million

Valuing a Business Example: Rio Corporation – continued

Valuing a Business Example: Rio Corporation – continued

Valuing a Business Example: Rio Corporation – continued

WACC & Debt Ratios Example continued: Sangria and the Perpetual Crusher project at 20% D/V Step 1 – r at current debt of 40% Step 2 – D/V changes to 20% Step 3 – New WACC

Adjusted Present Value APV = Base Case NPV + PV Impact Base Case = All equity finance firm NPV PV Impact = all costs/benefits directly resulting from project

Example: Project A has an NPV of $150,000. In order to finance the project we must issue stock, with a brokerage cost of $200,000. Adjusted Present Value

Example: Project A has an NPV of $150,000. In order to finance the project we must issue stock, with a brokerage cost of $200,000. Project NPV = 150,000 Stock issue cost =-200,000 Adjusted NPV- 50,000 dont do the project Adjusted Present Value

Example: Project B has a NPV of -$20,000. We can issue debt at 8% to finance the project. The new debt has a PV Tax Shield of $60,000. Assume that Project B is your only option. Adjusted Present Value

Example: Project B has a NPV of -$20,000. We can issue debt at 8% to finance the project. The new debt has a PV Tax Shield of $60,000. Assume that Project B is your only option. Project NPV = - 20,000 Stock issue cost = 60,000 Adjusted NPV 40,000 Do the project Adjusted Present Value

Example – Rio Corporation APV

Adjusted Present Value Example – Rio Corporation APV - continued