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
Date Written: December 2016
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: Suggested Citation