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Using the free cash flow valuation model, show the only avenues by which capital structure can affect the value of the firm
Using the free cash flow valuation model, show the only avenues by which capital structure can affect the value of the firm.
Expert Solution
Formula for free Cashflow model = Free cashflow/(1+ Weighted average Cost of Capital)
The weighted average cost capital is overall cost of capital for all funding sources in a company. Including stocks and debts.
WACC = %of debt* after tax cost of. Debt + % stock * Cost of stock
Increasing debt or reducing debt will be effect WACC, So, that will effect the value of the firm.
Changes in debt also effect the interest expense of firm, that also lead to change in free Cashflow
The impact of Capital structure on value depends upon the effect of debt on Weighted average Cost of Capital and Free Cashflow of the firm
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