With Subsidized Debt How Do We Adjust the Wacc?

8 Pages Posted: 31 Mar 2005

See all articles by Joseph Tham

Joseph Tham

Duke University - Duke Center for International Development in the Sanford School of Public Policy; Academy of Public Administration under the President of the Republic of Kazakhstan

Ignacio Velez-Pareja

Grupo Consultor CAV Capital Advisory & Valuation

Date Written: March 7, 2005

Abstract

In the standard Weighted Average Cost of Capital (WACC) applied to the free cash flow (FCF), we assume that the cost of debt is the market, unsubsidized rate. With debt at the market rate and perfect capital markets, debt only creates value in the presence of taxes through the tax shield. In some cases, the firm may be able to obtain a loan at a rate that is below the market rate. With subsidized debt and no taxes, there would be a benefit to debt financing, and the unlevered and levered values of the cash flows would be unequal. How would we adjust the WACC to take account of the subsidized debt? And how would we adjust the expression for the required return to levered equity?

In this paper, using a single period example we present the adjustments to the WACC with subsidized debt. We demonstrate the analysis for both the WACC applied to the FCF and the WACC applied to the capital cash flow (CCF). For simplicity, we assume that there are no taxes. The analysis can be extended easily to multiple periods in the presence of taxes.

Keywords: WACC, cost of capital, subsidized debt, valuation of cash flows, project evaluation, project appraisal, firm valuation, cost of capital, cash flows, free cash flow, capital cash flow

JEL Classification: D61, G12, G31, H43, M41

Suggested Citation

Tham, Joseph and Velez-Pareja, Ignacio, With Subsidized Debt How Do We Adjust the Wacc? (March 7, 2005). Available at SSRN: https://ssrn.com/abstract=680921 or http://dx.doi.org/10.2139/ssrn.680921

Joseph Tham (Contact Author)

Duke University - Duke Center for International Development in the Sanford School of Public Policy ( email )

Box 90312
302, Towerview Dr, Rubenstein Hall, Room 272
Durham, NC 27708
United States
919-613-9234 (Phone)
919-681-0831 (Fax)

HOME PAGE: http://fds.duke.edu/db/Sanford/faculty/thamjx

Academy of Public Administration under the President of the Republic of Kazakhstan ( email )

Abay Street, 33a
Astana
Kazakhstan
+7 8 7172753422 (Phone)

Ignacio Velez-Pareja

Grupo Consultor CAV Capital Advisory & Valuation ( email )

Ave Miramar # 18-93 Apt 6A
Cartagena
Colombia
+573112333074 (Phone)

HOME PAGE: http://cashflow88.com/decisiones/decisiones.html

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