Question

Capital Structure, WACC, and Firm Investment Suppose a firm can borrow money to finance projects from a bank at a marginal, pre- tax rate of 4.0%. Suppose the firm’s stock currently has a beta of 1.2, the market risk premium is 6% and the risk-free rate is 4.0%. The firm is currently financed with 40% debt and faces a 30% marginal tax rate. The firm is considering an average-risk project with the following free cash flows: Year 0 1 2 3 4 FCF -216,000 100,000 75,000 50,000 25,000 a. Compute the firm’s WACC. b. Compute the project’s NPV and IRR. c. Should the firm invest in the project? Why or why not? Now, assume that the CFO has determined that, when financing the project, the firm will also recapitalize so that the firm would be financed with 50% debt. d. Compute the firm’s unlevered beta. e. Compute the firm’s WACC after re-capitalizing. f. Re-calculate the project’s NPV. g. Has the firm changed its view of whether to accept the project? Explain why or why not.

Answer #1

WACC= Kd*(Wd) + Ke*(We)

Kd= 4%*(1-.3)

= 2.8%

Ke= 4% + 1.2*(6%)

=11.2%

a) WACC= 2.8%*(0.4) + 11.2%*(0.6) = 7.84%

b)

Year | Cash flow |

0 | -216000 |

1 | 100000 |

2 | 75000 |

3 | 50000 |

4 | 25000 |

WACC | 7.84% |

NPV | -425.1 |

IRR | 7.73% |

c) We should reject the project as we are getting a negative net present value.

d) Unlevered Beta = Equity Beta / [ 1 + ((1-t)*(D/E))]

= 1.2 / [1 + (0.7*1)]

= 0.70588

e) WACC = 2.8%*(0.5) + 11.2%*(0.5) = 7%

f)

Year | Cash flow |

0 | -216000 |

1 | 100000 |

2 | 75000 |

3 | 50000 |

4 | 25000 |

WACC | 7.00% |

NPV | 2853.1 |

IRR |
7.73% |

g) We will accept the project as WACC has decreased and NPV is positive.

Suppose that Free People is considering an investment in its
online portal. The investment will be evaluated using the firm’s
WACC. The firm’s cost of debt is 4.0%, tax rate is 35%, and beta is
.91. The risk-free rate is 2.5% and the market risk premium is 5%.
The firm’s shares currently sell for $8/share and there are 455
million shares outstanding. The firm has $2.2 billion in debt that
currently sells at par value and $2.0 billion in book...

You need to estimate a WACC for a firm whose asset (unlevered)
beta is 1. The firm will be 50% debt financed and its cost of debt
will be 7% based on a debt beta of 0.25 and a market risk premium
of 8%.
If the firm's corporate tax rate is 40%, what is the firm's
WACC?

Suppose your firm has decided to use a divisional WACC approach
to analyze projects. The firm currently has four divisions, A
through D, with average betas for each division of 0.8, 1.0, 1.5,
and 1.7, respectively. Assume all current and future projects will
be financed with 60 debt and 40 equity, the current cost of equity
(based on an average firm beta of 1.0 and a current risk-free rate
of 8 percent) is 15 percent and the after-tax yield on...

Suppose your firm has decided to use a divisional WACC approach
to analyze projects. The firm currently has four divisions, A
through D, with average betas for each division of 0.7, 1.0, 1.4,
and 1.6, respectively. Assume all current and future projects will
be financed with 60 debt and 40 equity, the current cost of equity
(based on an average firm beta of 1.0 and a current risk-free rate
of 3 percent) is 12 percent and the after-tax yield on...

Suppose your firm has decided to use a divisional WACC approach
to analyze projects. The firm currently has four divisions, A
through D, with average betas for each division of 0.6, 1.0, 1.3,
and 1.6, respectively. Assume all current and future projects will
be financed with 55 debt and 45 equity, the current cost of equity
(based on an average firm beta of 1.0 and a current risk-free rate
of 3 percent) is 14 percent and the after-tax yield on...

Suppose your firm has decided to use a divisional WACC approach
to analyze projects. The firm currently has four divisions, A
through D, with average betas for each division of 0.8, 1.0, 1.5,
and 1.7, respectively. Assume all current and future projects will
be financed with 50 debt and 50 equity, the current cost of equity
(based on an average firm beta of 1.0 and a current risk-free rate
of 6 percent) is 14 percent and the after-tax yield on...

Suppose your firm has decided to use a divisional WACC approach
to analyze projects. The firm currently has four divisions, A
through D, with average betas for each division of 0.5, 1.0, 1.2,
and 1.5, respectively. Assume all current and future projects will
be financed with 50 debt and 50 equity, the current cost of equity
(based on an average firm beta of 1.0 and a current risk-free rate
of 8 percent) is 13 percent and the after-tax yield on...

Your company has an equity cost of capital of 10%, debt cost of
capital of 6%, market capitalization of $10B, and an enterprise
value of $14B. Your company pays a corporate tax rate of 35%. Your
companymaintains a constant debt-to-equity ratio.
a)What is the (net) debt value of your company? (Hint:Net debt =
D–Excess cash)
b)What is the(net)debt-to-equity ratio of your company?
c)What is the unlevered cost of capital of your company?(Hint:When
a firm has a target leverageratio, its unlevered...

Chandeliers has no debt but it can borrow at 6.1%.
The firm has a WACC of 9.5% and tax rate is 35%.
What’s the firm’s cost of equity?
If the firm converts to 25% debt, what the equity cost will
be?
If the firm converts to 50% debt, what the equity cost will
be?
What’s the firm’s WACC at 25% debt?
What’s the firm’s WACC at 50% debt?

Suppose your firm has decided to use a divisional WACC approach
to analyze projects. The firm currently has four divisions, A
through D, with average betas for each division of 0.8, 1.2, 1.4,
and 1.6, respectively. Assume all current and future projects will
be financed with 20 percent debt and 80 percent equity, the current
cost of equity (based on an average firm beta of 1.1 and a current
risk-free rate of 7 percent) is 11 percent and the after-tax...

ADVERTISEMENT

Get Answers For Free

Most questions answered within 1 hours.

ADVERTISEMENT

asked 3 minutes ago

asked 4 minutes ago

asked 5 minutes ago

asked 9 minutes ago

asked 16 minutes ago

asked 1 hour ago

asked 1 hour ago

asked 2 hours ago

asked 2 hours ago

asked 2 hours ago

asked 2 hours ago

asked 2 hours ago