The example is based on a firm with forecasted revenues of 20,000 in year 1,

expecting to grow at 20% per year for the next two years, 10% the two following
years and to experience no growth thereafter. The other assumptions used in the
example are the following:

• margins (10% in year 1, 15% in year 2 and year 3, 20% after) 


• corporate tax (35%) 


• invested capital (60% of revenues in year 1, 55% in year 2 and 50% after, which
means that the invested capital turnover ratio remains constant at a level
of 2) 


• cost of debt (6.4%, which given a risk-free rate of 4% and a market risk
premium of 8% corresponds to a debt beta equal to .30) 


• unlevered beta or asset beta (=1)
 


Three different cases, associated with three different views on how to calculate
the Present Value 
 of the Tax Shields (PVTS), are presented. 


• The case where debt is rebalanced (with PVTS calculated using the unlevered
cost of capital) 


• The case where debt is not rebalanced (with PVTS calculated using the cost of
debt) 


• The case where debt is not rebalanced (using a methodology based on the
difference between the Present Value of taxes of the unlevered firm
discounted at the unlevered cost of capital and the Present Value of taxes
of the levered firm discounted at the cost of equity)