(Un)Levering the Cost of Equity and Financing Policy

When valuing companies in a DCF-framework, three methods are commonly applied: Adjusted Present Value (APV), the Weighted Average Cost of Capital (WACC), and valuation of the Cash Flow to Equity (CFE).

The use of the different methods, APV, WACC and CFE, are often thought to lead to different valuation results. We show though, that the three different methods are entirely consistent with each other, provided that the cost of equity is (un)levered in the right way.

In this first part of our paper, we will show how APV, WACC and CFE are related under two different financial policies: a constant level of debt and a constant Debt/Equity ratio of the firm. Depending on the financing policy of the firm, we show that the (un)levering should be done in different ways. The resulting valuations with the three methods will then be the same.

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A Practitioners Toolkit on Valuation, de Roon, van der Veer (2013)