Hey chimps,
I'm struggling with intuition behind the APV-method of valuing a firm as the sum of 1) the value of the unlevered firm plus 2) the present value of the tax shield from debt financing plus 3) potential bankruptcy costs. Would anyone care to explain why the actual interest expenses are not included in the calculation if the intention behind the APV-method is to isolate and illustrate the total effect of debt? Seems inconsistent to consider the tax shield, and not the interest expenses that cause the tax shield, but I might be missing something.
Many thanks,
BD Elliot
it's used in the case of changing capital structure of the company - so wacc is rendered useless due to changing proportions of debt and equity
So the cost of debt associated with taking on more debt is incorporated in the discount rate used to find the PV of the tax shield? It just seems unlikely that the tax shield, being a % of the interest expenses, could ever surpass the interest expenses and amount to a positive PV of taking on debt, but I think I might be slicing it wrong...
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