VALUATION
A.
Valuation steps
1.
2.
3.
B.
Estimate future cash flows
Determine required rate of return (discount rate k)
Find present value of cash flows
Applications of valuation
1.
2.
3.
2.
Bonds and stocks
Capital budgeting
Leasing
Mergers and acquisitions
Methods of evaluating projects
1.
Net Present Value (NPV)
n CF
t (where the initial cash flow is usually negative)
 
t
t  0 1  k 
2.
Internal Rate of Return (IRR)
n
CFt
 CF0

t
t 1 1  IRR 
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TAXES AND LEASES
 Because of tax laws, we have to worry about whether certain effects are taxable and how
much tax they incur. We also have to worry about whether a lease qualifies for the tax
benefits (especially if it is leveraged). The differences in tax rates between the lessee and the
lessor is typically why it is beneficial for both to enter into a leasing arrangement.
 One example is depreciation, which is a charge to earnings (a quasi-expense), but not an
actual cash flow. With qualified leases, assets can be depreciated faster for tax benefits.
 Another example is the sale of the asset. Whenever you sell an asset, you pay taxes on any
"profit" from the sale. Uncle Sam defines profit as:
 Profit = Selling Price - Book Value (where Book Value = Installed Cost of Asset Accumulated Depreciation)
Ex: If you sell an asset for $10,000, the book value is $6,000, and your tax rate is 40%
then: Profit = $10,000-$6,000=$4,000 and your net cash inflow is:
$10,000-.40($4,000)=$8,400.
2
A Typical Profile of Lessor’s Cash Flows:
Initial outlays or cash flows
Intermediate cash flows
Terminal cash flows
Purchase of assets – the net cash Lease payments net of tax Proceeds from sale of assets net
outlay or “net capitalized cost” if effects
of tax effects
lease is not leveraged
Maintenance costs net of
The owner’s equity invested in
tax savings
the purchase of the asset
Depreciation tax shields
Financing costs net of tax
savings on interest
3
COMPUTING THE LEASE PAYMENT TO MAKE NPV=0
1. NPV = 0 when:
Net Capitalization Cost C0 + PV(After-Tax Residual Value of Asset) = -PV(intermediate CF)
2. To calculate n equal intermediate monthly after-tax CF payments, use Excel’s pmt function:
=pmt(k/12, n, C0 + PV(After-Tax Residual Value of Asset))
3.
After-Tax Monthly CF payment = Depreciation tax shield + Lease payment * (1-T)
And therefore the
Lease Payment = (After-Tax Monthly CF payment – Depreciation tax shield)/(1-T)
4