The Adjusted Present Value (APV) approach can handle both perpetual and uneven cash flows. It can be used in calculating the adjusted present value of a levered firm that has many financing effects. The APV approach divides the NPV into two basic parts −The first part includes the all-equity NPV, assuming that the project is entirely financed by equity.The second part consists of the interest tax shields and all types of financing effects.We can write, $$\mathrm{APV = All\:Equity\:NPV\:+\:Value\:of\:Financing\:Effects}$$Steps in Adjusted Present Value ApproachThe use of APV consists of three steps −The first state of application of APV includes determination of ... Read More

Apart from Earning Per Share (EPS), value, and cash flow, there are additional factors that need to be considered while determining the capital structure of a company. Some of the most common factors are as follows −AssetsIf a company has more tangible assets, its chances of financial distress automatically goes down. Lenders can use the tangible assets to realize their funds by liquidating the assets in the case the company goes bankrupt. Hence, companies that do not have many tangible assets have debt at a costlier rate.Growth OpportunitiesThe companies with higher market-to-book value have a larger share of intangible assets ... Read More

Financial Slack is the Unused Debt CapacityBusinesses go through various conditions in their lifetime. There are times when companies earn high income which can be termed as profits or growth of revenues. On the other hand, some companies may go through a downturn in sales, profits, or revenues. In order to sail through such conditions, a company must have extra money. This extra money that can be used when the company is in trouble is known as the financial slack of the company.Financial slack is the untapped debt potential of a company. It may be availed from unused debt capacity, ... Read More

Equity cash flow is the amount of money a company can return to its investors after paying all the debt it acquired from the market. Also called free cash flows to equity, equity cash flows show the health of a company, as it contains the money that is left after paying all the loans the company has taken from the investors.How to Calculate Equity Cash Flows?While there are many formulas to calculate equity cash flows, the most common is the one that uses net income and changes in working capital.This formula is expressed as −Free Cash Flow to Equity    ... Read More

Financing effects are special kinds of considerations made for the companies or individuals who are weaker in terms of finances and may find it hard to obtain debt from the markets. The intention of financial effects is to help companies and individuals mitigate the financial burdens that may arise from time to time.Here are some prominent forms of financing effects.Subsidized LoansIn case of a subsidized loan, the lender pays the interest portion of the loan, reducing the burden of the borrower who may find it hard to pay back the interests on a loan taken for a certain reason, such ... Read More

Risk-free Debt is HypotheticalRisk-free debt is a hypothetical condition where the risk associated with the debt is zero. In general, there is no such thing as risk-free debt. While the risk of debt may go up and down in comparison, it can never be zero in any condition. This is apparent from the government bonds which carry minimum risk but not risk-free.Even when a collateral is issued against the debt resourced, the debt does not become risk-free. Investors should be aware that the company may be unable to provide the debt back in case of bankruptcy.It is notable that the ... Read More

A balance sheet is made up of assets and liabilities and hence the balance sheet approach of evaluating a firm shows the values of the assets of a company.Book Value of Assets is the Minimum Value of a FirmWhen the values are un-adjusted, the balance sheet approach indicates the claims of investors over the assets of the company. That is, the book value of equity funds and debt funds represent the value of the firm the investors have ownership on. Therefore, the minimum value of a firm is equal to the book value of assets.Value of a Firm is Worth ... Read More

The Free Cash Flow of a company depends on the following factors −Sales ProjectionExpense EstimationDepreciationCapital ExpenditureChanges in Net Working CapitalInterest ExpensesTax RatesInflationLet us discuss each of these factors in detail and see how they affect the Free Cash Flows of a company.Sales ProjectionTo determine the Free Cash Flow of a company, the first step is to determine its projected sales.Sales depend upon many factors, such as market share, growth, and demand of products in the market.A company cannot remain at one stage in terms of sales. There are normal, super-normal, and declining growth phases of a company.An analyst dealing with ... Read More

The Free Cash Flow approach using WACC for the evaluation of investment projects has certain limitations −Cash Flow PatternsThe original WACC is based on an assumption that cash flow patterns are perpetual. In fact, there is no such behavior in case of cash flow patterns. However, WACC works in all types of cash flows.Business RisksWACC assumes that a project or a business has the same risks as the existing assets of the company. This may be true in case of a small expansion in assets but for completely different types of businesses, this may not be applicable.The evaluation of a ... Read More

A pure-equity or an unlevered firm obtains all its funds internally and does not require to obtain any debt from the market. In other words, pure-equity firms are debt-free. Therefore, in case of an investment, a pure-equity firm doesn’t have to pay any interest for the debt the company may acquire from the market.Debt-free companies may use retained earnings or revenues generated from their existing projects to fund an investment project, so they do not need to acquire financing externally.Pure-equity firms use the asset cost of capital instead of the cost of equity to fund their investment projects. It is ... Read More