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CHAPTER18
VALUATIONANDCAPITAL
BUDGETINGFORTHELEVEREDFIRM
AnswerstoConceptsReviewandCriticalThinkingQuestions
1.APVisequaltotheNPVoftheproject(i.e.thevalueoftheprojectforanunleveredfirm)plusthe
NPVoffinancingsideeffects.
2.TheWACCisbasedonatargetdebtlevelwhiletheAPVisbasedontheamountofdebt.
3.FTEusesleveredcashflowandothermethodsuseunleveredcashflow.
4.TheWACCmethoddoesnotexplicitlyincludetheinterestcashflows,butitdoesimplicitlyinclude
theinterestcostintheWACC.Ifheinsiststhattheinterestpaymentsareexplicitlyshown,you
shouldusetheFTEmethod.
5.Youcanestimatetheunleveredbetafromaleveredbeta.Theunleveredbetaisthebetaoftheassets
ofthefirm;assuch,itisameasureofthebusinessrisk.Notethattheunleveredbetawillalwaysbe
lowerthantheleveredbeta(assumingthebetasarepositive).Thedifferenceisduetotheleverageof
thecompany.Thus,thesecondriskfactormeasuredbyaleveredbetaisthefinancialriskofthe
company.
SolutionstoQuestionsandProblems
NOTE:Allend-of-chapterproblemsweresolvedusingaspreadsheet.Manyproblemsrequiremultiple
steps.Duetospaceandreadabilityconstraints,whentheseintermediatestepsareincludedinthis
solutionsmanual,roundingmayappeartohaveoccurred.However,thefinalanswerforeachproblemis
foundwithoutroundingduringanystepintheproblem.
Basic
1.a.Themaximumpricethatthecompanyshouldbewillingtopayforthefleetofcarswithall-
equityfundingisthepricethatmakestheNPVofthetransactionequaltozero.TheNPV
equationfortheprojectis:
NPV=–PurchasePrice+PV[(1–t)(EBTD)]+PV(DepreciationTaxShield)
C
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