In the recent writings on valuation, there is no consensus about the correct formulas for calculating the relevant cost of capital in an M amp; M world. The proliferation of alpha number of methods and omega number of theories for the calculation of the cost of capital is puzzling because in the...

In the standard construction of the free cash flow (FCF) in the M amp; M world without taxes, it is assumed that ALL of the generated cash flow is distributed to the debt holder and the equity holder, and there are no surplus funds that are invested in short-term marketable securities. Under...

Recently, the residual income (RI) model has become very popular in valuation because it purports to measure quot;value addedquot; by explicitly taking into account the cost for capital in the income statement. Some proponents of the residual income approach have even suggested that the RI model...

The discount rate for the tax shield depends on the risk of the tax shield. If the tax shield is risk-free, then the appropriate discount rate for the tax shield is the risk-free rate rf. If the debt is risky, then we must make the distinction between the contractual return and the expected...

In a recent paper, Loeffler (2001) showed that the Miles amp; Ezzell (M amp; E) WACC allows arbitrage if the cash flow process does not have a quot;certain growth ratequot;. To be specific, for a particular period, the set of up and down coefficients must be the same at all the nodes in a...

This teaching note is a continuation of the previous teaching note on risk-neutral valuation. In Section One, we estimate the value of levered equity in a levered company in an M amp; M world with risk-free debt and without taxes. The structure of the presentation will facilitate the subsequent...

Risk-neutral valuation is simple, elegant and central in option pricing theory. However, in teaching risk-neutral valuation, it is not easy to explain the concept of 'risk-neutral' probabilities. Beginners who are new to risk-neutral valuation always have lingering doubts about the validity of...

The conventional wisdom about psi, the appropriate discount rate for the tax shield, is as follows. If the tax shield is risk-free, that is, the revenue is sufficient to ensure that the interest deduction will be used with full certainty in the relevant period, then the appropriate discount rate...

In the recent writings on valuation, there is no consensus about the correct formulas for calculating the relevant cost of capital in an M amp; M world. The proliferation of alpha number of methods and omega number of theories for the calculation of the cost of capital is puzzling because in the...

In the arena of valuation, the fanciful claims about the dethronement of the champion (a.k.a. NPV) by the concept of economic value added (EVA) have been greatly exaggerated, and it would be premature and unwise to abandon our reliable and trusted NPV. EVA is simply an interesting algebraic...