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On the Equivalence between the APV and the wacc Approach in a Growing Leveraged Firm
Author(s) -
Massari Mario,
Roncaglio Francesco,
Zanetti Laura
Publication year - 2008
Publication title -
european financial management
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 1.311
H-Index - 64
eISSN - 1468-036X
pISSN - 1354-7798
DOI - 10.1111/j.1468-036x.2007.00392.x
Subject(s) - economics , weighted average cost of capital , tax shield , debt , econometrics , context (archaeology) , equivalence (formal languages) , microeconomics , value (mathematics) , mathematics , public economics , finance , statistics , tax reform , profit (economics) , paleontology , individual capital , discrete mathematics , financial capital , gross income , biology , state income tax
While in a steady state framework the choice between the wacc approach (Modigliani‐Miller, 1963) and the adjusted present value (APV) approach (Myers, 1974) is irrelevant since the two approaches provide the same result, however, in a growing firm context the wacc equation seems to be inconsistent with the APV result. In this paper we propose a simple model to evaluate the tax savings in a growing firm in order to show under which assumptions the two approaches lead to the same results. We demonstrate that the use of the wacc model in a steady‐growth scenario gives rise to some unusual assumptions with regard to the discount rates to be used in calculating tax shields. We show that the widely used wacc formula, if used, as it is in most cases, in a growth context, implies that a) debt tax shield related to already existing debt are discounted using k d ; b) debt tax shield related to new debt, due to company's growth, are discounted, according to a mixed procedure, using both k u and k d . We discuss the inconsistency of such a discounting procedure and the preferred features of the APV approach.