- We have to make consistent assumptions about
terminalvalueinourdiscountedcashflowandEVA
valuations.In thespecial case,wherethereturnon
capital on all investments—existing and new—is
equaltothecostofcapitalaftertheterminalyear,this
issimpletodo.Theterminalvaluewillbeequalto
thecapitalinvestedatthebeginningoftheterminal
year.Inthemoregeneralcase,wehavetoensurethat
thecapitalinvestedatthebeginningoftheterminal
yearisconsistentwiththeassumptionaboutreturnon
capitalinperpetuity.Inotherwords,iftheafter-tax
operatingincomeintheterminalyearis$1.2billion
andweareassumingareturnoncapitalof 10 percent
inperpetuity,wehavetoset thecapitalinvestedat
the beginning of the terminal year to be $12 billion.
CAPITAL STRUCTURE AND FIRM VALUE
BoththecostofcapitalapproachandtheAPVapproachmake
the value of a firm a function of its financial leverage.
Implicitly, we are assuming that the value of a firm is
determinednotjustbytheinvestmentsitmakesbutalsoby
the mix of debt and equity that it uses to fund these
investments.Whilethismayseemlogical,thereissubstantial
debateincorporatefinanceonwhetherthefinancialleverage
ofafirmshouldaffectitsvalue.Inthischapter,wewillbegin
with a quickreview of both sides of the capital structure
argumentandthenconsiderpracticalwaysofanalyzingthe
effect of capital structure on value.
Should Capital Structure Affect Value?