thanequity?Willthevaluesforequityobtainedfromthefirm
valuation approach be consistent with the values obtained
from the equity valuation approaches described in the
previous chapter?
Theadvantageofusingthefirmvaluationapproachis that
cash flowsrelating to debt do not haveto be considered
explicitly, sincetheFCFFis a predebtcash flow,whereas
theyhavetobe takenintoaccount inestimating FCFE.In
caseswheretheleverageisexpectedtochangesignificantly
overtime,this isa significantsaving,sinceestimatingnew
debtissuesanddebtrepayments whenleverageischanging
canbecomeincreasinglymessythefurtherintothefutureyou
go. The firm valuation approach does, however, require
informationaboutdebtratiosandinterestratestoestimatethe
weighted average cost of capital.
In theory, the value for equity obtained from the firm
valuationandequityvaluationapproachesshouldbethesame
ifyoumakeconsistentassumptionsaboutfinancialleverage.
Gettingthemtoconvergeinpracticeismuchmoredifficult.
Letusbeginwiththesimplestcase—ano-growth,perpetual
firm.Assumethatthefirmhas$166.67millioninearnings
beforeinterestandtaxesandataxrateof 40 percent.Assume
thatthefirmhasequitywithamarketvalueof$600million,a
costofequityof13.87percent,debtof$400million,anda
pretaxcostofdebtof 7 percent.Thefirm’scostofcapitalcan
be estimated.