Answer 23

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Read more on debt to net from firm value

You would need to subtract out the market value of anything that you considered debt for your cost of capital calculation. Thus, you should subtract out the market value of all interest bearing debt, short as well as long term, and the present value of operating leases and other off-balance sheet debt that you can identify. Why market rather than book value? Even if the book value of debt is substantially higher than market value, a discounted cash flow valuation is based upon a going concern assumption and going concerns pay the cashflows on debt as they come due (and the market value reflects the present value of these cashflows). An alternative is do a liquidation valuation of the assets of the firm and subtract out the book value of the debt outstanding.

If your firm has other potential obligations, this is the place to show them. For instance, a tobacco firm can be expected to lose at least some of the lawsuits that are pending against it. The expected value of the payout (as a result of losing the lawsuit) should be subtracted from firm value to get to equity value.  For firms with under funded pension and health care plans, you should subtract out the extent of the underfunding to get to the value of equity.



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