FIGURE 10.4 Gross Debt versus Net Debt
Approaches—Implicit Assumptions ($ millions)
ILLUSTRATION10.2:ValuingaLeveredFirmwithCash:
Gross Debt and Net Debt Approaches
Considerafirmwith$1billioninvestedinoperatingassets,
earning an after-tax return on capital of 12.5% on its
operating investments, and $250 million invested in cash,
earning4%risklessly;thereisnoexpectedgrowthinearnings
fromeithercomponent,andtheearningsareexpectedtobe
perpetual.Assumethat theunleveredbeta oftheoperating
assets is 1.42 and that the firm has $500 million in
outstandingdebt(withapretaxcostofdebtof5.9%).Finally,
assumethatthemarketvalueofequityis$1billion,thatthe
firmfacesataxrateof40%,andthattheequityriskpremium
is 5%.
Gross Debt Valuation