Vl = EBIT (1-t) / Rwacc ; Vu = EBIT (1-t) / R0
As titled, I am having issue understanding and using those two equations, I dont see them on the notes and the EOC pactices on reading 24 relied heavily on them. How should I comprehend those? It seems the EOC use these two equations to derive implied Rwacc or R0 and insert those for other calculations, can someone walk me through where these come from?
I must admit I am also fuming in anger to see this in CFA curriculum; the sheer amount of theory and assumptions should easily render it useless for any professional use. In 1985 an Economics Nobel Prize was simply wasted. Pardon for the strong language.
Getting back to the equations, here is a small improvement.
VL=value leveraged= EBIT (1-t)/WACC
VU=value unleveraged= EBT (1-t)/WACC (this is WACC with zero debt, i.e. it is simply the cost of equity).
i know, i was like where on earth is this from and the exercises were all over these two, I just simply cant understand this, how to think of it?
The equations seem confusing at first, but when you step back and think about it - they begin to make sense.
If you use EBIT(1-t) as a proxy for CF, you can use the DCF approach to value the firm.
For a levered firm, VL, you would want to discount this CF using the WACC since we are accounting for debt and equity.
An unlevered firm has zero debt, so your going to discount the CF proxy using R0, which is the cost of equity assuming no debt and thus your WACC.
You have no idea what you’re talking about.
And the last equation is simply NI/Ke, but that’s the market value of equity, not the value of an unlevered company.
I think the formula makes good sense to me, its logical, you just have to understand it.