7 relativetofirmvalue.Theindirectcostsofbankruptcycan
besubstantial,butthecostsvarywidelyacrossfirms.Shapiro
andTitmanspeculatethattheindirectcostscouldbeaslarge
as 25 percentto 30 percentoffirmvaluebutprovidenodirect
evidenceofthecosts.Altman(1984)estimatesthecosttobe
15 percent in a study of seven firms that went bankrupt
between 1980 and 1982.
8
ILLUSTRATION 6.6: Valuing a Firm with the APV
Approach: Titan Cement
InIllustration6.2,wevaluedTitan Cementusingacost of
capitalapproach.Here,wereestimate thevalueofthefirm
using an adjusted present value (APV) approach in three
steps.
- Compute unlevered firm value. When we valued Titan
earlier,weusedtheleveredbetaforthecompanyof0.93and
thedebt-to-capitalratioof17.6%toestimateacostofcapital
fordiscountingthefreecashflowstothefirm.IntheAPV
approach,weusetheunlevered betaof0.8to estimatethe
unlevered cost of equity, For the first five years, with a
risk-freerate of3.41%and a riskpremium of 4.46%,this
yields a cost of equity of 6.98%.
Beyondyearfive,wewilluseanunleveredbetaof0.875to
correspond with the levered beta of 1 used in Illustration 6.2.
9 Withthemarketriskpremiumreducedto4%,thisyieldsa
cost of equity of 6.91%.