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Assumptions Taken in The Calculations
Assumptions Taken in The Calculations
Since the project is intended to be carried on for more than 15 years, the R f is taken
as the bond yield of the 30yr government bond which is 8.24%
Beta unlevered i.e., 0.82 is used to calculate the unlevered cost of capital – using the
CAPM formula of Re = Rf + (Rm- Rf) and that gave us a figure of 12.50%
For calculation of the cost of debt – the yield of BB rated bond is taken which is
equivalent to the Ba3 rated bond of Apache Corporation (12.30%)
For calculating tax rate – the effective tax rate for every year is found as a fraction of
the total income taxes on the income before income taxes. And then we have taken
the average of all the numbers to arrive at the rate of 35.31% as the tax rate
Historical debt/capital ratio has been provided in the case and using that we have
found the average debt/capital ratio of Apache Corporation taking it as the average
of the numbers from 1986-1990 – 50.32%. the corresponding debt/equity ratio
comes out to be 1.0129
Levered beta is calculated as L = UL * ( 1+(1-t)*D/E) and the same comes out to be
1.3573. using that we calculated the levered cost of equity which is 15.30%
We have taken the cash flows from Exhibit 7 which gives the aggregate cash flows from all
the different reserves and then discounted it using the unlevered cost of capital to get the
Present Value to get a value of $488.24m. We add to it the present value of the tax shield
which is calculated as follows – we found the Free Cash Flows at every point in time over the
15 years of the project discounting it at WACC; since the cash flows basically relate to the
value of the firm, we use the debt/capital ratio to find out the debt component in the
financing and then multiplied the amount with the cost of debt to find the interest
payments. Applying the tax rate on the interest payments, we found the interest tax shield
and then discounted it using the unlevered cost of capital to get the present value of tax
shield i.e., $69.63m. Adding it to the figure of $488.24m we get the Present Value as
$557.87m.