Adjusted beta and Adjusted

Net Present Value

Chapter 15
Systematic Risk
• Business Risk
• Financial Risk
• Levered= Debt + Equity
• Unlevered----Total Equity Company
Adjusting the Beta for Financial Leverage
Adjusting the Beta for Financial Leverage
Adjusting Beta for Financial
Leverage
bj = bju [ 1 + (B/S)(1 – TC) ]

b j: Beta of a levered firm.

bju: Beta of an unlevered firm
(an all-equity financed firm).
B/S: Debt-to-Equity ratio in
Market Value terms.
TC : The corporate tax rate.
• Rearranging equation we get unlevered Beta

• Bj=1.4,
• B/S=0.70
• Tax rate =0.40
• Unlevered beta Bju= 0.99=1
Adjusting beta with Your Company Leverage
bj = bju [ 1 + (B/S)(1 – TC) ]
=0.99[1+(0.30)(1-0.40)]
B/S=0.30
T=0.40
Bju=0.99
Proxy beta A=1.4
B=1.17
 Adjusted Present Value
Adjusted Present Value (APV) is the sum of the
discounted value of a project’s operating
cash flows plus the value of any tax-shield
benefits of interest associated with the
project’s financing minus any flotation
costs.
Unlevered Value of
APV = Project Value
+ Project Financing
Adjusted Net Present Value

APV = NPV + PV of TS – Flotation Cost

APV =( $423,054 – $425,000) + ($13,513 – $10,000)
APV = $1,567
 NPV and APV Example
Assume Basket Wonders is considering a new
$425,000 automated basket weaving machine
that will save $100,000 per year for the next 6
years. The required rate on unlevered equity is
11%.
BW can borrow $180,000 at 7% with $10,000
after-tax flotation costs. Principal is repaid at
$30,000 per year (+ interest). The firm is in the
40% tax bracket.
Basket Wonders NPV Solution

What is the NPV to an all-equity-

financed firm?

NPV = $100,000[PVIFA11%,6] – $425,000

NPV = $423,054 – $425,000
NPV = – $1,946
 Basket Wonders APV
Solution
What is the APV?
First, determine the interest expense.
Int Yr 1 ($180,000)(7%) = $12,600
Int Yr 2 ( 150,000)(7%) = 10,500 Int Yr
3 ( 120,000)(7%) = 8,400 Int Yr 4
( 90,000)(7%) = 6,300 Int Yr 5
( 60,000)(7%) = 4,200 Int Yr 6
( 30,000)(7%) = 2,100
 Basket Wonders APV
Solution
Second, calculate the tax-shield benefits.
TSB Yr 1 ($12,600)(40%) = $5,040/(1.07)^1= 4710
TSB Yr 2 ( 10,500)(40%) = 4,200/(1.07)^2= 3668
TSB Yr 3 ( 8,400)(40%) = 3,360/(1.07)^3= 2743
TSB Yr 4 ( 6,300)(40%) = 2,520/(1.07)^4= 1922
TSB Yr 5 ( 4,200)(40%) = 1,680/(1.07)^5 =1198
TSB Yr 6 ( 2,100)(40%) = 840/(1.07)^6=560
=14801
Adjusted Net Present Value

APV = NPV + PV of TS – Flotation Cost

APV =( $423,054 – $425,000) + ($14801 – $10,000)
APV = $2855
Basket Wonders NPV Solution

What is the APV?

APV = NPV + PV of TS – Flotation Cost
APV = –$1,946 + $14801 – $10,000
APV = $2855