The translation between the required return on unlevered and levered equity for explicit cash flows and fixed debt financing

Becker, Denis

doi:10.1108/mf-02-2020-0069

Cited by 2 publications

(3 citation statements)

References 22 publications

Supporting

Mentioning

Contrasting

Order By: Relevance

“…Furthermore, the ratios DVt EV L;t and TSVt EV L;t need to be established by means of additional information. It is furthermore important to notice that this formula is applicable in the recursive computation (backward induction) of firm values as illustrated in Becker (2020). This means that we cannot assume that some or all parameters are constant throughout time.…”

Section: Literature Review On Valuation Of Cash Flows With Limited Li...mentioning

confidence: 99%

“…This allows for discounting the unconditional expectations of the cash flows and values. Hence, it is possible to use a deterministic backward induction scheme of the form (as opposed to a stochastic backward iteration shown in Becker, 2020Becker, , 2021:…”

Section: Behavior Of Cash Flows Values and Discount Rates For Fcf Ann...mentioning

confidence: 99%

“…Many researchers have therefore questioned to what extent the framework of Modigliani and Miller (1963) and their successors is applicable for cases when the FCF is not a constant perpetuity. Myers (1974), Beranek (1975), Arditti and Levi (1977), Ben-Horim (1979), Miles and Ezzell (1980), V elez-Pareja (2005, 2019), Brusov et al (2011Brusov et al ( , 2014 and Becker (2020Becker ( , 2021 have investigated cases where cash flows have a limited lifetime. Nevertheless, until today no complete and plausible set of valuation equations has been developed for an FCF that comes as a stochastic annuity.…”

Section: Introductionmentioning

confidence: 99%

See 2 more Smart Citations

Getting the valuation formulas right when it comes to annuities

Becker

2022

Self Cite

View full text Add to dashboard Cite

PurposeThe purpose of this paper is to establish the flow-to-equity method, the free cash flow (FCF) method, the adjusted present value method and the relationships between these methods when the FCF appears as an annuity. More specifically, we depart from the two most widely used evaluation settings. The first setting is that of Modigliani and Miller who based their analysis on a stationary FCF. The second setting is that of Miles and Ezzell who worked with an FCF that represents an autoregressive possess of first order.Design/methodology/approachInspired by recent observations in the literature concerning cash flows, discount rates and values in discounted cash flow (DCF) methods, we mathematically derive DCF valuation formulas for annuities.FindingsThe following relationships are established: (a) the correct discount rate of the tax shield when the free cash flow takes the form of a first-order autoregressive annuity, (b) the direct valuation of the tax shield from the free cash flow for a first-order autoregressive annuity, (c) the correct translation from the required return on unlevered equity to the levered equity, when the free cash flow is a stationary annuity and (d) direct calculation of the unlevered and levered firm values and the value of the tax shield for a stationary annuity.Originality/valueUntil now the complete set of formulas for the valuation of stochastic annuities by different DCF methods has not been established in the literature. These formulas are developed here. These formulas are important for practitioners and academics when it comes to the valuation of cash flows of finite lifetime.

show abstract

Section: Literature Review On Valuation Of Cash Flows With Limited Li...mentioning

confidence: 99%

Section: Behavior Of Cash Flows Values and Discount Rates For Fcf Ann...mentioning

confidence: 99%

Section: Introductionmentioning

confidence: 99%

See 1 more Smart Citation

Getting the valuation formulas right when it comes to annuities

Becker

2022

Self Cite

View full text Add to dashboard Cite

show abstract

Consistent DCF Methods for Constant-Growth Annuities à la Modigliani & Miller or Miles & Ezzell

Becker

2024

Journal of Business Valuation and Economic Loss Analysis

View full text Add to dashboard Cite

In this paper, we develop two complete discounted-cash flow (DCF) frameworks for the valuation of constant-growth annuities and perpetuities. By ‘complete’ we mean that these frameworks allow the valuation of a firm or project by means of different DCF methods, particularly, the equity method, the free-cash-flow (FCF) method, the adjusted-present-value-method, and the capital-cash-flow method. This also requires the derivation of formulas that allow the translation between different required returns, like the required return on unlevered and levered equity, the discount rate in the FCF method, and the required return on the tax-shield. Our paper departs from the two most advocated and mutually exclusive frameworks when dealing with DCF. The first is based on Modigliani and Miller (M&M), where the FCF at different points in time are independently distributed. The second framework rests on the analysis of Miles and Ezzell (M&E) who presume a first-order autoregressive cash-flow process. Some elements of a ‘complete’ framework exist in the literature, but in our opinion, a complete picture has not been developed yet. The contributions of this paper are the following: (1) We develop (or expand) the set of formulas that are required for the valuation of constant-growth annuities and perpetuities; (2) The formulas we develop in this paper are based on a backward-iteration process, which in itself represents a suitable tool for firm valuation; (3) Using a numerical example, we show that the two mutually exclusive frameworks of M&M or M&E achieve very different valuation results; (4) It turns out that the expected returns and the growth rate of the FCF are partly linked, but this relationship is different in the two frameworks; (5) In our numerical examples, we show how the constant-growth annuity or perpetuity, can be integrated with an explicitly planned FCF.

show abstract

The translation between the required return on unlevered and levered equity for explicit cash flows and fixed debt financing

Cited by 2 publications

References 22 publications

Getting the valuation formulas right when it comes to annuities

Getting the valuation formulas right when it comes to annuities

Consistent DCF Methods for Constant-Growth Annuities à la Modigliani & Miller or Miles & Ezzell

Contact Info

Product

Resources

About