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Under the comparative firms approach of valuation, companies are valued depending on groups formed with the key relationships of the companies. The groups of companies are formed with similar companies or similar transactions to determine the value of a firm. By deciding the group of company, the general trends are applied to each company of a group. Since the valuation is done by comparison, the approach is known as comparative firms approach.A Simple Approach in Evaluating a CompanyThe comparative firms approach is based on the fact that similar companies should have the same value and should sell for similar prices.It ... Read More
In the Adjusted Present Value (APV) approach, the after-tax subsidy is applied on after-tax cost of debt. That is, the company availing the financial subsidy gets a tax relief on their after-tax cost of loans. The debt of a company directly affects its value and hence the after-tax cost of debt also affects the company's finances. In fact, the companies get both savings in the tax paid as well as on the interest tax shield.Subsidized Financing Increases the Value of a ProjectA company paying 15 percent tax and receiving 5 percent subsidy will have to pay the interest at 10 ... Read More
When we consider fixed debt ratio and debt rebalancing, both the interest shields and Free Cash Flows are discounted at the opportunity cost of capital of the project to determine the Adjusted Present Value (APV). So, one can combine these two flows and discount them by the opportunity cost of capital.Under Fixed Capital StructureSince FCFs plus interest tax shields equal the Capital Cash Flows (CCF), the CCF and APV approaches under fixed capital structure are the same. Under the assumption of fixed capital structure, CCFs, FCFs and APVs are all equal.The FCF value is widely used to determine the valuation ... Read More
One can easily obtain the beta of a company that is publicly quoted in the market. The beta is available in the peer group of companies and it can be obtained easily. The beta calculations are required to determine the required cost of capital of the companies. These betas are, however, required to be adjusted for the varying leverage. This adjustment of leveraging is done through leveraging and unleveraging of the beta.In determining the cost of capital via the Capital Asset Pricing Model (CAPM) in the context of valuation of corporate firms, it is stated that the cost of capital ... Read More
The WACC concept assumes that debt is always a constant proportion of the value of a project. This means that with the changes in project value, the debt value must change to keep the WACC value as it is. For example, with a debt proportionality value of 60% for a project, the value of debt must remain 60% of the project value each year. This means that even with reducing project value, the amount of debt value should change in a proportion of 60%.Why Do We Need Debt Rebalancing?We need to tweak the debt proportion value in order to keep ... Read More
The WACC method is not directly used to determine the value of a project. However, the hurdle rate of a project can be determined by using WACC which can then lead to determine whether a project can be viable for a company to a new project. The underlying assumption in using the hurdle rate of a project includes the following.No Change in Capital StructureConstant capital structure means that the debt-to-equity ratio remains the same over the entire period of the project. In case WACC is to be used in determining the hurdle rate, then the capital structure should remain the ... Read More
The financing policies of a company usually need to be sustainable and feasible in the long term. Companies want to make decisions that may make financial policies more feasible and sustainable. The measures opted for this must ensure that the growth of the company is in sync with the policies set by the company. The policies that need to be followed for sustainable growth are included in the sustainable growth model of a company.Assumptions of Sustainable Growth ModelThe sustainable growth model aims to achieve long-term financial goals by managing the different elements of the model. The sustainable growth model is ... Read More
Capital Cash Flow (CCF) is a unique approach to calculate the worth of an investment project. In deciding the value of a project, there are two scenarios in which the CCF approach may be calculated. While there are some basic differences in these two approaches, the result obtained using these approaches are the same. These two scenarios are: fixed debt and fixed debt-to-value ratio.The CCF method differs from the Free Cash Flow (FCF) method in the sense that in FCF, the interest tax shield is applied in the discount rate rather than on the cash flows of the firm. The ... Read More
Apart from Earning Per Share (EPS), value, and cash flow, there are additional factors that need to be considered while determining the capital structure of a company. Some of the most common factors are as follows −AssetsIf a company has more tangible assets, its chances of financial distress automatically goes down. Lenders can use the tangible assets to realize their funds by liquidating the assets in the case the company goes bankrupt. Hence, companies that do not have many tangible assets have debt at a costlier rate.Growth OpportunitiesThe companies with higher market-to-book value have a larger share of intangible assets ... Read More
Financial Slack is the Unused Debt CapacityBusinesses go through various conditions in their lifetime. There are times when companies earn high income which can be termed as profits or growth of revenues. On the other hand, some companies may go through a downturn in sales, profits, or revenues. In order to sail through such conditions, a company must have extra money. This extra money that can be used when the company is in trouble is known as the financial slack of the company.Financial slack is the untapped debt potential of a company. It may be availed from unused debt capacity, ... Read More