cashflows.Earningtherisk-adjustedrequiredreturn(costof
capitalorequity)isconsideredanormalreturncashflow,but
anycashflowsaboveorbelowthisnumberarecategorizedas
excessreturns;excessreturnscanthereforebeeitherpositive
ornegative.Withtheexcessreturnvaluationframework,the
value of a business can be written as the sum of two
components:
Ifwemake theassumptionthat theaccountingmeasure of
capitalinvested(bookvalueofcapital)isagoodmeasureof
capital investedin assetstoday, this approachimplies that
firms thatare expectedto earnpositiveexcess returncash
flows will trade at market values higher than their book
valuesand thatthe reversewill be truefor firms that are
expected to earn negative excess return cash flows.
In the second variation, called the adjusted present value
(APV) approach, weseparate the effects onvalue of debt
financing from the value of the assets of a business. In
general, using debtto funda firm’s operations creates tax
benefits(becauseinterestexpensesaretaxdeductible)onthe
plus side and increases bankruptcy risk (and expected
bankruptcycosts)ontheminusside.IntheAPVapproach,
the value of a firm can be written as follows:
Incontrasttotheconventionalapproach,wheretheeffectsof
debt financing arecaptured in thediscount rate, the APV
approach attemptsto estimatetheexpecteddollar value of