12: 55 (6) Unfolding Capital Cash Flow Valuation

The expected asset return

The expected asset return will be the rate at which the future cash flows

will be discounted to calculate the present value of the company. The

pre-tax WACC is an appropriate measure of the riskiness of the capital

cash flows.

Pre-tax WACC = D/V*KD + E/V*KE

D/V is the debt to value ratio; E/V is the equity to value ratio;

KD and KE are the costs of debt and equity, respectively.

KD/E = RF + βD/E * RP

Pre-tax WACC = RF + (D/V* βD + E/V* βE)* RP

The beta of assets is a weighted average of debt and equity beta.

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14/12/2021, 12:55

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4/8

i.e. βA = D/V* βD + E/V* βE

So, pre-tax WACC = RF + βA* RP

It can be observed that the discount rate depends on the risk-free rate,

the asset beta, and the risk premium; and not on the equity or debt

percentages of the company. So when the capital structure changes,

there is no need to recalculate the discount rate.