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Adjustment of the WACC with Subsidized Debt in the Presence of Corporate Taxes: the N-Period Case

Ignacio Velez-Pareja (), Joseph Tham and Viviana Fernandez
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Joseph Tham: Duke University

Finance from University Library of Munich, Germany

Abstract: In the Weighted Average Cost of Capital (WACC) applied to the free cash flow (FCF), we assume that the cost of debt is the market, unsubsidized rate. With debt at the market rate and perfect capital markets, debt only creates value in the presence of taxes through the tax shield. In some cases, the firm may be able to obtain a loan at a rate that is below the market rate. With subsidized debt and taxes, there would be a benefit to debt financing, and the unleveraged and leveraged values of the cash flows would be unequal. The benefit of lower tax savings are offset by the benefit of the subsidy. These two benefits have to be introduced explicitly. In this paper we present the adjustments to the WACC with subsidized debt and taxes and the cost of leveraged equity for multiple periods. We demonstrate the analysis for both the WACC applied to the FCF and the WACC applied to the capital cash flow (CCF). We use the calculation of the Adjusted Present Value, APV, to consider both, the tax savings and the subsidy. We show how all the methods match.

Keywords: Adjusted Present Value; APV; weighted average cost of capital; discounted cash flow; DCF equity value; cost of equity; WACC; subsidized debt with taxes; valuation of cash flows; project evaluation; project appraisal; firm valuation; cost of capital; cash flows; free cash flow; capital cash flow (search for similar items in EconPapers)
JEL-codes: D61 G30 G31 G32 H43 (search for similar items in EconPapers)
Pages: 13 pages
Date: 2005-04-06
New Economics Papers: this item is included in nep-acc and nep-pbe
Note: Type of Document - pdf; pages: 13
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Related works:
Journal Article: Adjustment of the WACC with Subsidized Debt in the Presence of Corporate Taxes: The N-Period Case (2005) Downloads
Working Paper: Adjustment of the WACC with Subsidized Debt in the Presence of Corporate Taxes: the N-Period Case (2005) Downloads
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Persistent link: https://EconPapers.repec.org/RePEc:wpa:wuwpfi:0504006

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