Corporate Finance

How does debt change a valuation?

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Value operating cash flows at WACC, or use APV to add each financing effect separately. Learn the assumptions behind both methods, then practise with 10 worked Solve questions.

Market weights and the tax saving · Step 1 of 12

Count what investors would pay today

Debt and equity at market value

Market: total $12M

Debt: $4.8MEquity: $7.2M

Market weights and the tax saving · Step 1 of 12

Count what investors would pay today

Cloudcoil Lanternworks is our invented company throughout this lesson. Its 400,000 shares and its debt divide the market value between shareholders and lenders. Their weights must use market values, rather than the amounts recorded in the accounts.

Try it: Change the share price or debt value. Watch the mix change.

Share price ($)$18.00

Debt market value ($ million)$4.8M

Equity

$7.2M

Firm value

$12M

Debt weight

40.00%

E = shares × price = (400,000 × 18) = $7,200,000.

V = D + E = (4,800,000 + 7,200,000) = $12,000,000.

Debt weight = D ÷ V = (4,800,000 ÷ 12,000,000) = 40.00%.

Equity weight = E ÷ V = (7,200,000 ÷ 12,000,000) = 60.00%.

All lesson cash flows arrive at year end, with annual compounding. Assume enough taxable income to use every interest tax shield; the tax rate is a given of this example. In the loan examples each tax shield is treated as being as risky as the debt, and the stated debt rate is both the loan’s interest rate and its required return.

Check yourself

For WACC, which debt amount belongs in D?

Exam coming up and you are not sure when to use WACC and when APV?

Bring your problem sets. We work through them together until every type feels routine.

Book a session Next toolNext: Midterm practice: corporate finance

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How does debt change a valuation?

Count what investors would pay today

Count what investors would pay today

After-tax WACC from market values

Exam coming up and you are not sure when to use WACC and when APV?

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