Date: Tuesday, April 17, 2007
Read:
1. Valuing Companies: An Overview of Analytical Approaches (UVA-F-1187)
2. Using APV: A Better Tool for Valuing Operations by Timothy A. Luehrman, HBR Reprint 97306
Network File: APV.xls
Assignment:
Today’s class will be an overview of various valuation approaches. I suggest you look over the first two readings to get the larger picture of valuation. Some of the details will be clearer as we go through the course.
Luehrman’s article on APV (Adjusted Present Value) makes it sound like APV is much superior to the WACC methodology. In class we will discuss some of the factors that work in favor of WACC: in part, these have to do with difficulties in estimating unlevered discount rates and valuing interest tax shields. Both of these steps typically require some specific assumptions about capital structure theory (e.g. to unlever betas).
In preparation for the class look at the spreadsheet file (APV.xls) which contains the base case assumptions shown on page 5 of the Luehrman article. Using these data, construct valuations using each of the following approaches.
1. Weighted Average Cost of Capital
a. What is the appropriate cash flow in period 1?
b. What is the appropriate discount rate?
c. What is the terminal value?
d. What is the value of the investment?
2. Adjusted Present Value
a. What is the appropriate cash flow in period 1?
b. What is the appropriate discount rate?
c. What is the terminal value?
d. What is the value of the investment?
Assume for simplicity that the cost of unlevered equity is 13.5% and the government bond rate is 5.0%.