CCF method
The capital cash flow is calculated by adding the interest tax shield to
the free cash flow. The interest tax shield is the product of tax rate, cost
of debt and amount of debt. The amount of debt can be an absolute
value or a percentage of the enterprise value.
In this case, using either FCF or CCF will take an approximately equal
amount of effort. But, in the next case, this might not be the case.
Risky debt and a changing capital structure
FCF method
The assumption that the debt is risky in this case adds some
complication to the formula for unlevering the asset beta.
ΒE = (βA – D/V * βD) * V/E
Since the capital structure changes in each period, it is necessary to
calculate the after-tax WACC for each period too. The resulting after-
tax WACCs increase as the percentage of debt decreases in the capital
structure. This is because, with the fall in percentage debt, the benefit of
debt financing reduces. On the other hand, there is no change in the pre-
tax WACC, even with a change in capital structure.
The free cash flows are discounted using the after-tax WACC. Since
every year’s WACC is different, the discount rate for each period is
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14/12/2021, 12:55
(6) Unfolding Capital Cash Flow Valuation | LinkedIn
https://www.linkedin.com/pulse/unfolding-capital-cash-flow-valuation-parag-nawani/
6/8
calculated as a compounded rate that uses the preceding years’ after-tax
WACCs.
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