Abstract

http://ssrn.com/abstract=901181
 
 

Citations



 


 



Proper Solution of Circularity in the Interactions of Corporate Financing and Investment Decisions: A Reply to the Financing Present Value Approach


Ignacio Velez-Pareja


Master Consultores

Joseph Tham


Duke University - Duke Center for International Development in the Sanford School of Public Policy


Management Research News, Vol. 28, No. 10, pp. 65-92, January 2005

Abstract:     
It is a well known problem the interactions between the market value of cash flows and the discount rate (usually the weighted average cost of capital, WACC) to calculate that value. This is mentioned in almost all textbooks in corporate finance. However, the solution adopted by most authors is to assume a constant leverage D%, and hence assume that the leverage gives raise to an optimal capital structure and the discount rate is constant.

On the other hand, most authors use the definition of the Ke, the cost of leveraged equity for perpetuities even if the planning horizon is finite. Among these authors we find the work of Wood and Leitch W&L 2004.

In this paper we wish to analyze the claim made by W&L 2004 in the sense to have found an iterative solution to the problem of circularity that results in a near matching with the Adjusted Present Value APV, proposed by Myers, 1974. They use as the basic principle the fact that there is a near constant relation between Ke the cost of equity and Kd the cost of debt. They consider as well that the cost of debt Kd is not constant and changes proportionately with the leverage D%.

We propose a very simple and precise approach to solve the above mentioned circularity problem.

Keywords: Adjusted Present Value, APV, weighted average cost of capital, circularity problem, discounted cash flow, DCF equity value, cost of equity

JEL Classification: G30, G31, G32

Accepted Paper Series


Not Available For Download

Date posted: May 16, 2006  

Suggested Citation

Velez-Pareja, Ignacio and Tham, Joseph, Proper Solution of Circularity in the Interactions of Corporate Financing and Investment Decisions: A Reply to the Financing Present Value Approach. Available at SSRN: http://ssrn.com/abstract=901181

Contact Information

Ignacio Velez-Pareja (Contact Author)
Master Consultores ( email )
Ave Miramar # 18-93 Apt 6A
Cartagena
Colombia
+575 690 9972 (Phone)
HOME PAGE: http://cashflow88.com/decisiones/decisiones.html
Joseph Tham
Duke University - Duke Center for International Development in the Sanford School of Public Policy ( email )
Box 90312
302, Towerview Dr, Rubenstein Hall, Room 272
Durham, NC 27708
United States
919-613-9234 (Phone)
919-681-0831 (Fax)
HOME PAGE: http://fds.duke.edu/db/Sanford/faculty/thamjx
Feedback to SSRN


Paper statistics
Abstract Views: 461

© 2014 Social Science Electronic Publishing, Inc. All Rights Reserved.  FAQ   Terms of Use   Privacy Policy   Copyright   Contact Us
This page was processed by apollo5 in 0.235 seconds