Capital budgeting with leverage

Capital budgeting with leverage

1. 1. Which valuation method discounts the unlevered free cash flow at the unlevered cost of capital, then adds the PV of the tax shield separately?

   WACCAPV (Adjusted Present Value)FTE (Flow to Equity)Dividend Discount Model

2. 2. WACC is the most natural choice when:

   The firm maintains a stable D/V ratio over timeDebt is scheduled to pay down rapidlyYou want equity value directly without separately computing debtThere are no taxes

3. 3. If WACC, APV, and FTE give different valuations for the same project, the most likely causes are:

   Cost of equity not properly levered for the assumed D/ECash-flow definitions inconsistent (FCF vs FCFE)Capital structure changes over time being ignored in WACCThe three methods are fundamentally different and can't agree

4. 4. Perpetual after-tax FCF of $10M, $40M of perpetual debt at 5%, tax rate 25%, unlevered cost of capital r_U = 11%. Compute total firm value V via APV. Answer in $M.

   $M