Advanced Corporate Finance. 4. Project Valuation using the WACC

Transcription

1 Advanced Copoate Finance 4. Poject aluation using the WACC

2 Objectives of the session So fa, NP concept and possibility to move fom accounting data to cash flows. Influence on taxation on fim value: OK. But necessity to go futhe and undestand the impact of the capital stuctue on poject valuation in geneal. This sessions objectives 1. Review the ways to analyze the impact of capital stuctue on investment decisions (AP, wacc and FT) 2. etemine values of the wacc in function of capital stuctue objectives 2

3 Inteactions between capital budgeting and financing The NP fo a poject could be affected by its financing. (1) Tansactions costs (2) Inteest tax shield Thee ae seveal ways to poceed, one elies on adjusting the NP fo the financing cost, the othes adjust the discount ate: The AP Appoach: Compute a base case NP, and add to it the NP of the financing decision ensuing fom poject acceptance AP = Base-case NP + NP(Financingecision) The Adjusted Cost of Capital Appoach: Adjust the discount ate to account fo the financing decision 3 3

4 Basis of easoning o you emembe this expession? (emembe also its assumptions!) L = U + Tc = + FCF unleveed WACC FCF Unleveed a Tc ( d ) t = (1 + t 1 d) FCF leveed o k e FCF to equity WACC way AP FT Thee methodologies that should be consistent unde cetain assumptions and context! Simple context: eveything can be summaized in a ate Pepetuity! thee is a single WACC (à pioi) while we can discount any seies of CFs quite explicitly with any specific value each peiod. 4

5 Fo a given poject, thee methods If we assume pepetual Cash Flows WACC t =1 (1 + FCF U, t WACC ) t I AP t = 1 FCF (1 + U, t t a ) + P ( financinge ffects ) I FT t = 1 FCF (1 + L, t t e ) ( I ) 5

6 MM (1963) with taxes: Copoate Tax Shield Inteest payments ae tax deductible tax shield Tax shield = Inteest payment Maginal Copoate Tax Rate d T c : cost of new debt : maket value of debt alue of leveed fim = alue if all-equity-financed + P(Tax Shield) P(Tax Shield) - Assume pemanent boowing P ( TaxShield ) = Othe assumptions? alue of the fim: L = U +T c Tc d = Tc d 6

7 The Adjusted Pesent alue The most staightfowad. Pemits the use to see the souces of value in the poject, if it's accepted Pocedue: (1) Compute the base-case NP using a discount ate that employs all equity financing ( A ), applied to the poject's cash flows (2) Then, adjust fo the effects of financing which aise fom: Flotation costs Tax Shields on ebt Issued ffects of Financing Subsidies» AP = NP + NPF 7

8 AP xample ata Cost of investment 10,000 Incemental eanings 1,800 / yea uation 10 yeas iscount ate A 12% NP = -10, ,800 x a 10 = 170 (1) Stock issue: Issue cost : 5% fom goss poceed Size of issue : 10,526 (= 10,000 / (1-5%)) Issue cost = 526 AP = =

9 AP xample (2) Boowing Suppose now that 5,000 ae boowed to finance patly the poject Cost of boowing : 8% Constant annuity: 1,252/yea fo 5 yeas Copoate tax ate = 40% Yea Balance Inteest Pincipal Tax Shield 1 5, , , , , , , P(Tax Shield) = 422 AP = = 592 9

10 Adjusted Pesent alue Has some stong defendes => see Luehman (1997) fo an easy to ead discussion Stong points allows easily to detemine and analyze the pecise impact of vey diffeent actions linked to capital stuctue (tax shields but also costs of financial distess, subsidies, hedges, cost of issue etc..) Unbundling of each facto (in this espect wacc is much moe opaque) Possible to undestand the espective contibution of each assumption (see Luehman, 1997) Pobably easie to communicate asy when amount of debt to issue is known 10

11 Minus points Adjusted Pesent alue Need to detemine the pope ate to discount the Tax shield (not so simple, so fa assumption that d is the pope ate) When we have a taget leveage atio : necessity to solve fo both the debt level AN the poject value (but less of an issue with a speadsheet allowing iteative calculation) Not easy to implement when we have a debt/equity atio 11

12 Playing with the discount ate Altenative appoaches ely on a discount ate adjusted fo the financial decisions One of the most commonly used measue: the weighted aveage cost of capital (wacc) Afte tax WACC fo leveed company: WACC = + (1 TC )!NB!:, and ae MARKT ALUS not book value NB: With this fomula, only the tax shield is taken into account 12

13 WACC -Sangia Copoation Balance Sheet (Book alue, millions) Assets 100 ebt 50 quity 50 Total 100 Total 100 Cost of equity 14.6% Cost of debt (petax) 8% Tax ate 35% Balance Sheet (Maket alue, millions) Assets 125 ebt 50 quity 75 Total 125 Total 125 quity atio = / = 75/125 = 60% ebt atio = / = 50/125 = 40% WACC = (1.35) =

14 Using the WACC WACC is used to discount fee cash flows (unleveed) xample: Sangia Cop. consides investing $12.5m in a machine. xpected pe-tax cash flow = $ 2.085m (a pepetuity) Afte-tax cash flow = (1-0.35) = NP Bewae of two taps: = =.1084 (1) Risk of poject might be diffeent fom aveage isk of company (2) Financing of poject might be diffeent fom aveage financing of company 0 14

15 Using the WACC New poject may have an influence on the capital stuctue itself! WACC may change ove time! A change in the capital stuctue in the futue will automatically lead to a change in wacc value Need to detemine the WACC value unde seveal scenaio Modigliani-Mille (1963) => assumptions: CF is a pepetuity, debt is a constant Miles-zzel (1980, 1985) => assumptions any FCF, taget leveage atio (L = t / t ) is a constant with a ebalancing of the debt at a given time inteval Hais and Pingle (1985) assumptions any FCF, taget leveage atio (L = t / t ) is a constant with a continuous ebalancing of the debt 15

16 WACC - Modigliani-Mille fomula Remembe that T u c a + d = e + d L L L L And L = U +T c, thus T L c a = e + d (1 Tc ) L L L Since WACC = + (1 T C ) Then WACC = A ( 1 T L) C 16

17 Anothe pesentation Assumptions!!! => FCF t = BIT(1-T C ) Maket value of unleveed fim: U = BIT (1-T C )/ A Maket value of leveed fim: = U + T C = BIT (1 T A ) C + T C efine: L / Solve fo : = BIT ( 1 T ) BIT (1 T = (1 T L) WACC A C C C ) 17

18 MM fomula: example ata Investment 100 Pe-tax CF A 9% 5% T C 40% Base case NP: (1-0.40)/.09 = 50 Financing: Boow 50% of P of futue cash flows afte taxes = 0.50 Using MM fomula: WACC = 9%( ) = 7.2% NP = (1-0.40)/.072 = Same as AP intoduced peviously? To see this, fist calculate. As: = U + T C = and: = 0.50 = = = AP = NP 0 + T C = =

19 Using standad WACC fomula Step 1: calculate using = A + ( A )(1 TC ) As / = 0.50, / = 1 = 9% + (9% - 5%)(1-0.40)(0.50/(1-0.50)) = 11.4% Step 2: use standad WACC fomula WACC = ( 1 T + C ) WACC = 11.4% x % x (1 0.40) x 0.50 = 7.2% Same value as with MM fomula 19

20 Assumptions: Miles-zzel: WACC fomula with taget leveage atio Any set of cash flows ebt atio L = t / t constant whee t = P of emaining afte-tax cash flow emonstation see Miles-zzel (1980) => main point to undestand, since debt is adjusted annually, tax shield will change, the value of the shield will be known only one yea in advance, fo the est of the time the shield is isky and should be discounted at a WACC = A LT C A 20

21 Miles-zzel example ata Investment 300 BIT (1-Tc) Yea 1 50 Yea Yea Yea Yea 5 50 A 10% 5% T C 40% L 25% Base case NP = = Using Miles-zzel fomula WACC = 10% x 0.40 x 5% x 1.10/1.05 = 9.48% AP = P(Taxshield) = = WACC FCF discount = = Initial debt: 0 = = (0.25)(344.55)=86.21 ebt ebalanced each yea: Yea t t Tax Shield Using MM fomula: WACC = 10%( x 0.25) = 9% AP = = ebt: = 0.25 = (0.25)(349.21) = No ebalancing 21

22 Hais and Pingle (1985) Assumption: any fee cash flows debt ebalanced continously t = L L,t the isk of the tax shield is equal to the isk of the unleveed fim emonstation see Hais and Pingle (1985). Idea vey close to Miles- zzel, main diffeence hee continuous ebalancing => uncetainty elated to next yea s tax shield => need to discount it at a WACC = A d T C L 22

23 Hais and Pingle: xample Using Hais and Pingle s fomula WACC = 10% x 0.40 x 5% = 9.50% AP = P(Taxshield) = = WACC FCF discount = = Initial debt: 0 = = (0.25)(344.63)=86.16 ebt ebalanced each yea: Yea t t Tax Shield

24 «In shot» Modigliani Mille Miles zzel Hais-Pingle Opeating CF Pepetuity Finite o Pepetual Finite of Pepetual ebt level Cetain Uncetain Uncetain Fist tax shield Cetain Cetain Uncetain WACC L = / A (1 T C L) (/) + (1-T C )(/) A T C L Cost of equity A +( A )(1-T C )(/) A +( A ) (/) Beta equity β A +(β A β )(1-T C )(/) 1+ d (1 Tc ) β A +(β A β )(/) a + ( a A LT d C βa (1 + ) ( a d (1 + Tc ( d d A L )) 1 L ) Souce: Taggat Consistent aluation and Cost of Capital xpessions With Copoate and Pesonal Taxes Financial Management Autumn

25 Adjusting WACC fo debt atio o business isk Step 1: unleve the WACC = + Step 2: stimate cost of debt at new debt atio and calculate cost of equity = + ( ) Step 3: Recalculate WACC at new financing weights O Step 1: Unleve beta of equity β asset = βequity + βdebt Step 2: Releve beta of equity and calculate cost of equity β equity = βasset + ( βasset βdebt ) Step 3: Recalculate WACC at new financing weights 25