hard · Investment Banking valuation-core
A target generates $100M of unlevered FCF growing at 2% in perpetuity. Its asset (unlevered) beta is 0.90; the risk-free rate is 4%, the equity risk premium is 5%. The target currently carries $400M of debt at a 6% pre-tax cost and a 25% tax rate, and will hold debt CONSTANT in dollar terms going forward. An analyst values it via APV: she discounts the unlevered FCF at the unlevered cost of equity to get enterprise value, then adds the tax shield.
Which treatment of the interest tax shield is internally consistent with the firm's stated financing policy, and what is its value?
- Discount the perpetual tax shield at the unlevered cost of equity, giving a tax-shield value of about $63M.
- Discount the perpetual tax shield at the pre-tax cost of debt, giving a tax-shield value of $100M.
- Discount the perpetual tax shield at the WACC, giving a tax-shield value of about $75M.
- The shield is already captured by levering the beta, so APV would double-count it and its incremental value is zero.
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