It is a well known problem the interactions between the market value of cash flows and the discount rate (usually the weighted average cost of capital, WACC) to calculate that value. This is mentioned in almost all textbooks in corporate finance. However, the solution adopted by most authors is...

In a forthcoming paper, Fernandez (2002) claims to derive a formula for the valuation of debt tax shields for firms with cash flows that grow perpetually at a constant rate. We show that his formula is incorrect and provide an example where his valuation would admit arbitrage

In theory, different valuation methods, with consistent assumptions, must give identical results. Numerical examples that purport to illustrate the theory should demonstrate the identical results. Unfortunately, in popular textbooks it is all too easy to find numerical examples that are at odds...

In this teaching note, we discuss the basic principles for tariff setting. Tariff setting is very important for regulated industries, such as water and power. The tariff should provide an appropriate risk-adjusted return to the investor. If the tariff were too low, then the investors would not...

Although perpetuities are somewhat artificial in the sense that in practice they do not exist, they are relevant because no matter how detailed and complex a forecasted financial plan for a firm or project could be terminal value usually is calculated as perpetuity. This terminal value might be...

In the latest edition of Principles of Corporate Finance (Brealey, Myers and Allen, 2006) the authors use a finite cash flow example to illustrate the valuation procedure for using the Discounted Cash Flow (DCF) method with the free cash flow (FCL) and the Adjusted Present Value (APV). The two...

In the latest edition of Principles of Corporate Finance (Brealey, Myers and Allen, 2006) the authors use a finite cash flow example to illustrate the valuation procedure for using the Discounted Cash Flow (DCF) method with the free cash flow (FCF) and the Adjusted Present Value (APV). The two...

In this note we analyze the tutorial based on the McKinsey methodology for valuing companies. We have found that the McKinsey methodology has one of the most common mistakes mentioned in Tham and Veacute;lez-Pareja (2004a and b): valuing cash flows with a constant cost of capital when the...

For cash flows in perpetuity without growth, analysts typically use the following formula for the return to levered equity Ke.lt;brgt;lt;brgt;Ke = Ku + (Ku shy; Kd)(1 shy; T)D/E (1) lt;brgt;lt;brgt;where Ku is the return to unlevered equity, Kd is the cost of debt, T is the tax rate, D is the...

In cash flow valuation (CFV), there are two main categories of mistakes: derivation of the appropriate cash flows and estimation of the cost of capital. A simple-minded view of the world would suggest that with near perfect capital markets, the presence of arbitrage would severely punish wrong...