TWO DCF APPROACHES FOR VALUING COMPANIES UNDER ALTERNATIVE FINANCING STRATEGIES (AND HOW TO CHOOSE BETWEEN THEM)

Isik Inselbag and Howard Kaufold

Journal of Applied Corporate Finance, 1997, vol. 10, issue 1, 114-122

Abstract: This is the sequel to the authors' 1989 article discussing the two basic discounted cash flow approaches for valuing debt‐financed transactions and corporations: weighted average cost of capital (WACC) and adjusted present value (APV). The WACC method discounts all after‐tax (but pre‐interest) cash flows at the company's weighted average cost of capital. The APV method treats the value of a levered firm as the value of the same firm if financed entirely with equity plus the discounted value of the interest tax shields from the debt its assets will support. The authors argue that the WACC approach is more practical if the firm intends to hold its (market) leverage ratio relatively constant over time, but that the APV technique is the preferred method if the firm plans to reduce its leverage ratio according to a pre‐determined schedule (as tends to be the case in highly leveraged transactions).

Date: 1997
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