In this chapter, one must have learned the responsibilities of a corporate manager which includes:
So the question now is how to work upon the NPV that is net present value of the firm under the presence of such mentioned issues along with capital structure that has an ability to change the same. How will capital structure and firm value be determined under the working of imperfections of capital market?
In order to answer all the questions, one must recall a fact about the perfect market which states that average capital cost is not equal to marginal capital that can be compared in any internal return rate of a new project. A significant difference can be seen in a scenario raising cost of one more dollar and that of billion dollars.
And hence, the current capital cost is just considered as a number in the balance sheet which is of no use. On the other hand, the average capital cost is more useful if the forces that influenced the average capital cost are likely to repeat influence the marginal capital cost currently as well. In fact, the average capital cost is somewhere near to the marginal capital cost of today in majorly large firms.
The figure 18.5 is a demonstration of the value of the firm considering various perspectives in the market. The value of the firm can be 100$ but it is considered 80$ under imperfections of market. In addition to tax shelter which is created under tax deductibility, other factors can equally significant under the algebraic formula of APV as well as WACC. One can see in the extreme row where income tax corporate mitigation is broken down with worth value of 5$.
And under such a situation, corporate income taxes were not a significant factor in the same because only 5$ reduction is noticed under 20$ of reduction because of income taxes of corporate. The rest of 15$ reduction due to market imperfection is more significant in such a case where it enters the value of the firm by directly associating with 75$ of the Net present value of the firm. Under such a case, one can think of an approach of APV related to other imperfections but such methods would be rarely useful. Why, if you ask?
18.10 A Do You Need Other Valuation (APV or WACC) Formulas?
There are certain methods with which you can understand proper income tax handling technique.
If fully taxed, capital cost and expected cash flows could help in corporate income tax reduction and also inducing extra debt shelter.
Expected cash flow and working with it is easy because of corporate income taxes (actual) that is reflected. This can also be stated as a flow to equity methodology.
In order to have a direct equivalent related to methodologies like flow to equity, capital cost and expected cash flows will be reflecting the following factors.
You can easily optimize your company by considering these facts. This can be a handy option which can definitely give you and your company protection from market imperfection.