PhD Finance - Selecting A Capital Budgeting Technique: WACC Vs. APV Vs. FTE – Coursework Example
Capital Budgeting Techniques Compare and contrast capital budgeting techniques Adjusted present value (APV) is used in the valuation of projects on the all-equity basis. This means that the after-tax cash flows of a project under all equity financing is placed as the numerator of the capital budgeting equation.
Weighted average cost of capital (WACC) is a technique that is used in the calculation of after-tax cash flows of a project with the assumption of all-equity financing (UCF), where the denominator of the capital budgeting equation is the UCF.
In the flow of equity (FTE) approach, after-tax cash flow is discounted from a project that is going to the shareholders of a levered firm.
Weighted average cost of capital (WACC), adjusted present value (APV), and the flow to equity are used in performing a similar task. All the three capital budgeting techniques provide similar valuation estimate.
WACC method normally discounts the after cash flows at the weighted average debt and cost of equity in valuing projects while the APV method equates the value of a project as though it was all-equity financed plus the tax shields present value. On the other hand, the FTE method takes to account all payment from and to debt holders, which are disocunted using the levered equity cost of capital in determining the value of a project.
Weighted average cost of capitals (WACC) is the easiest to apply and especially when a firm targets a debt-to-value ratio to the whole life of the project. Most firms and managers think in terms of target-to-value ratios hence the applicability of WACC.
The study will investigate the different capital budgeting techniques that are suitable for evaluation of different projects with different risks.
Gaps in knowledge
There exist gaps in knowledge between the theory behind capital budgeting techniques and application. There is lack of knowledge regarding capital budgeting theories and the application of the techniques
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