APV and WACC with Constant Book Leverage Ratio

Abstract

We value a company that targets its capital structure in book-value terms. This capital structure definition provides us with a Value of Tax Shields that lies between those of Modigliani-Miller (fixed debt) and Miles-Ezzell (fixed market-value leverage ratio). If a company targets its leverage in market value terms, has less value than if it targets the leverage in book value terms. How could some manager target leverage in market value terms? We also present empirical evidence that permits to conclude that debt is more related to the book value of the assets than to their market value.

Keywords: value of tax shields, required return to equity, WACC, company valuation, APV, cost of equity

JEL Classification: G12, G31, G32, M41