Goldilocks and the Three WACCs

Abstract

This paper presents three different approaches for calculating the levered annual values for a finite cash flow profile. In the first approach, we use K_U, the return to unlevered equity to calculate the annual tax savings and use K_U to calculate the (present) value of the tax savings. In the second approach, we use K_D, the cost of debt to calculate the annual tax savings and use K_U to calculate the (present) value of the tax savings. In the third approach, we use K_D, the cost of debt to calculate the annual tax savings and the (present) value of the tax savings.

Keywords: Financial modeling, Valuation, Weighted Average Cost of Capital (WACC), Free Cash Flow (FCF)

JEL Classification: D61, H43, M21, M40, M46, G12, G31, G33