Consistent Valuation of Project Finance and LBO's Using the Flows-to-Equity Method

26 Pages Posted: 14 Dec 2010 Last revised: 5 Jan 2017

See all articles by Ian A. Cooper

Ian A. Cooper

London Business School

Kjell G. Nyborg

University of Zurich - Department of Banking and Finance; Centre for Economic Policy Research (CEPR); Swiss Finance Institute

Multiple version iconThere are 2 versions of this paper

Date Written: December 2016

Abstract

A common method of valuing the equity in highly leveraged transactions is the flows-to-equity method. When applying this method various formulas can be used to calculate the time-varying cost of equity. In this paper we show that some commonly used formulas are inconsistent with the assumptions about the debt plan. We show that the error resulting from using the wrong formula can be large at the currently low levels of interest rates. We derive an equity releveraging formula which captures the effects of a time-varying fixed debt plan, expensive debt, and costs of financial distress, and discuss the relative merits of using the flows-to-equity method or APV.

Keywords: Valuation, flows-to-equity, equity cash flow, cost of equity, project finance, LBO

JEL Classification: G12, G24, G31, G32, G33, G34

Suggested Citation

Cooper, Ian Anthony and Nyborg, Kjell G., Consistent Valuation of Project Finance and LBO's Using the Flows-to-Equity Method (December 2016). Swiss Finance Institute Research Paper No. 10-51, Available at SSRN: https://ssrn.com/abstract=1724593 or http://dx.doi.org/10.2139/ssrn.1724593

Ian Anthony Cooper

London Business School ( email )

Sussex Place
Regent's Park
London, London NW1 4SA
United Kingdom
+44 171 262 5050 (Phone)

Kjell G. Nyborg (Contact Author)

University of Zurich - Department of Banking and Finance ( email )

Plattenstrasse 14
Zürich, 8032
Switzerland
+41 (0)44 634 2980 (Phone)

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Swiss Finance Institute

c/o University of Geneva
40, Bd du Pont-d'Arve
CH-1211 Geneva 4
Switzerland

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