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I have a quick question about changing business and/or financial risk…
I understand that…. when a company takes out a load of debt to finance a project, I should ungear and use APV,
and when a company moves into a different business, I should ungear and regear?what if a company moves into a new area whilst taking out loads of debt to do so? What would I do then? Or wouldn’t that come up…
thanks!
You should find the beta of the project (using the beta of a similar company and ungearing it if the similar company is geared).
Then calculate the NPV of the project using the return calculated using the beta above.
Then the APV by adding to the NPV above, the present value of the tax benefit from the debt used for the project.
ok, so to confirm… ungear the proxy company, and apply that ungeared Ke to the project cash flows, and follow the usual APV steps from there?
similar to change of financial risk, but we are ungearing the proxy company and applying to our own CFs?
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