Thefirststepinthisapproachistheestimationofthevalueof
theunleveredfirm.Thiscanbeaccomplishedbyvaluingthe
firmasifithadnodebt,bydiscountingtheexpectedfreecash
flowtothefirmattheunleveredcostofequity.Inthespecial
casewherecashflowsgrowataconstantrateinperpetuity,
the value of the firm is easily computed.
whereFCFF 0 isthecurrentafter-taxoperatingcashflowto
thefirm,ρu is theunlev-ered cost ofequity, and gis the
expectedgrowthrate.Inthemoregeneralcase,wecanvalue
thefirmusinganysetofgrowthassumptionswebelieveare
reasonableforthefirm.Theinputsneededforthisvaluation
aretheexpectedcashflows,growthrates,andtheunlevered
costofequity.Toestimatethelastinput,wecandrawonour
earlier analysis(in Chapter2) and use theunlevered beta
(obtained by lookingatcomparable firms) to arrive atthe
unlevered cost of equity.
Expected Tax Benefit from Borrowing
Thesecond step in this approach isthe calculationof the
expected taxbenefit from a givenlevel of debt.This tax
benefit is a function of the tax rate of the firm and is
discountedatthecostofdebttoreflecttheriskinessofthis
cash flow. If the tax savings are viewed as a perpetuity,