Consistent Cash Flow Valuation with Tax‐Deductible Debt: A Clarification

7 Pages Posted: 7 Sep 2013

Date Written: September 2013

Abstract

Massari et al. (2008) argue that the weighted average cost of capital (WACC) approach to discounting expected cash flows is generally inconsistent with the adjusted present value (APV) approach. We show that their argument results from, first, taking a WACC expression that assumes a fixed level of debt in perpetuity and applying it to a scenario where the debt level varies stochastically; and, second, discounting the tax savings from stochastic debt at the rate appropriate for fixed debt. Our paper draws attention to the fundamental proposition by which such errors are avoided when cross‐referencing valuation methods. The outcome is that the APV and WACC methods are shown to be algebraically consistent with each other.

Keywords: valuation techniques, growth, APV, wacc, tax‐shields

Suggested Citation

Dempsey, Michael J., Consistent Cash Flow Valuation with Tax‐Deductible Debt: A Clarification (September 2013). European Financial Management, Vol. 19, Issue 4, pp. 830-836, 2013, Available at SSRN: https://ssrn.com/abstract=2321972 or http://dx.doi.org/10.1111/j.1468-036X.2011.00625.x

Michael J. Dempsey (Contact Author)

Ton Duc Thang University (TDTU) ( email )

District 7
Ho Chi Minh City, 3001
Vietnam

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