On the Equivalence between the Apv and the Wacc Approach in a Growing Levered Firm

Abstract

One of the most discussed topics in the corporate valuation theory is the choice between the wacc approach (Modigliani-Miller [1963]) and the APV (Myers [1974]). Although in a steady state framework the choice is irrelevant since the two approaches provide the same result, in a growing firm context the WACC equation seems to be inconsistent with the APV result.

In this paper we propose a new scheme to evaluate the tax savings in a growing firm. The main idea is first to split the tax savings generated by the outstanding debt (at time zero) from tax savings generated by the future debt issues (undertaken according with the assumption of a constant debt to equity ratio). Once we've separated the two different tax savings we discount them using two different discount rates: the cost of debt (kd) for the 'outstanding' tax savings and the unlevered cost of equity (ku) for the tax savings due to the future debt issues. Finally we show that using our model the MM [1963] equation works both in a growing firm (g > 0) and in a steady state firm (g = 0).