CAPITAL PROJECT ANALYSIS AND THE DEBT TRANSACTION PLAN

This paper reexamines the conflict between the weighted average cost of capital (WACC) and the adjusted present value (APV) approaches to capital budgeting analysis. These 2 approaches will generally not yield the same levered valuations of a project's cash flows. Moreover, since both embody id...

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Bibliographic Details
Published in:The Journal of financial research 1983-04, Vol.6 (1), p.25-31
Main Authors: Ezzell, John R., Miles, James A.
Format: Article
Language:English
Subjects:
Analysis
Capital budgeting
Capital costs
Corporate finance
Present value
Techniques
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Summary:This paper reexamines the conflict between the weighted average cost of capital (WACC) and the adjusted present value (APV) approaches to capital budgeting analysis. These 2 approaches will generally not yield the same levered valuations of a project's cash flows. Moreover, since both embody identical assumptions regarding a project's unlevered value, the difference between the levered valuations produced by the 2 methods is due to different assumptions regarding the present value of the interest tax shields. Specifically, the difference between the levered valuations is found to arise from different assumptions about the nature of the incremental debt transactions. For the WACC approach to provide correct valuations, incremental debt transactions must be undertaken to maintain a constant leverage ratio in terms of realized market value. The APV approach provides correct valuations only if the debt transaction plan produces known levels of future debt.
ISSN:0270-2592
1475-6803
DOI:10.1111/j.1475-6803.1983.tb00308.x