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A new approach to WACC, value of tax savings and value for growing and non growing perpetuities: A clarification

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  • Ignacio Velez-Pareja

Abstract

In this note we correct the findings reported by Vélez-Pareja and Tham (2005). Although perpetuities are somewhat artificial in the sense that in practice they do not exist, they are relevant because no matter how detailed and complex a forecasted financial plan for a firm or project could be, terminal value usually is calculated as aperpetuity. This terminal value might be a growing or a non growing perpetuity. On the other hand, usually terminal value is a substantial part of the firm value.We examine in detail the proper discount rate for cash flows in perpetuity, the present value of tax savings and the calculation of terminal value, which is the value of the perpetuity. We compare the typical textbook proposals for calculating the value of a perpetuity and we found that there are significant deviations. We compare with the Miller and Modigliani (1961) plowback proposal adopted by Copeland et al. (2000). The findings contradict what is generally accepted in the literature.

Suggested Citation

  • Ignacio Velez-Pareja, 2007. "A new approach to WACC, value of tax savings and value for growing and non growing perpetuities: A clarification," Proyecciones Financieras y Valoración 4322, Master Consultores.
    • Handle: RePEc:col:000463:004322
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    Keywords

    WACC; perpetuities; terminal value; tax savings;
    All these keywords.

    JEL classification:

    • D61 - Microeconomics - - Welfare Economics - - - Allocative Efficiency; Cost-Benefit Analysis
    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
    • H43 - Public Economics - - Publicly Provided Goods - - - Project Evaluation; Social Discount Rate

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