PV of UCF 1989-93 at 14% PV of uTv at 14% 12333 Total unlevered value $24,557 PV of tax shields 1989-93 at 13. 5% PV of tax shields in Tv at 13.5% 1.544 Total value of tax shield 5.42 Total value 29,978 Less value of assumed debt 5.000 Number of shares 229 million Value per share $109.07 Concluding Comments on LBO Valuation Methods The WACC method is by far the most widely applied approach to capital budgeting. One could analyze an lBo and generate the results of the second section of this appendix using this technique, but it would be a much more difficult process. We have tried to show that the APV approach is the preferred way to analyze a transaction in which the capital structure is not stable over time Consider the WACC approach to valuing the kkr bid for RR. One could discount the operating cash flows of RR by a set of weighted average costs of capital and arrive at the same $30 billion total value for the company. To do this, one would need to calculate the appropriate rate for each year since the WACC rises as the buyout proceeds. This occurs because the value of the tax subsidy declines as debt principal is repaid In other words, there is no single return that represents the cost of capital when the firms capital structure is changing There is also a theoretical problem with the WACC approach to valuing a buyout. To calcul ate the changing WACC, one must know the market value of a firms debt and equity. But if the debt and equity values are already known, the total market value of the company is also known. That is, one must know the value of the company to calculate the WACC. One must therefore resort to using book-value measures for debt and equity, or make assumptions about the evolution of their market values of their market values, in order to implement the WACC methPV of UCF 1989-93 at 14% 12,224 PV of UTV at 14% 12,333 Total unlevered value $24,557 PV of tax shields 1989-93 at 13.5% 3,877 PV of tax shields in TV at 13.5% 1,544 Total value of tax shields 5,421 Total value 29,978 Less value of assumed debt 5,000 Value of equity $24,978 Number of shares 229 million Value per share $109.07 Concluding Comments on LBO Valuation Methods The WACC method is by far the most widely applied approach to capital budgeting. One could analyze an LBO and generate the results of the second section of this appendix using this technique, but it would be a much more difficult process. We have tried to show that the APV approach is the preferred way to analyze a transaction in which the capital structure is not stable over time. Consider the WACC approach to valuing the KKR bid for RJR. One could discount the operating cash flows of RJR by a set of weighted average costs of capital and arrive at the same $30 billion total value for the company. To do this, one would need to calculate the appropriate rate for each year since the WACC rises as the buyout proceeds. This occurs because the value of the tax subsidy declines as debt principal is repaid. In other words, there is no single return that represents the cost of capital when the firm’s capital structure is changing. There is also a theoretical problem with the WACC approach to valuing a buyout. To calculate the changing WACC, one must know the market value of a firm’s debt and equity. But if the debt and equity values are already known, the total market value of the company is also known. That is, one must know the value of the company to calculate the WACC. One must therefore resort to using book-value measures for debt and equity, or make assumptions about the evolution of their market values of their market values, in order to implement the WACC method