Question

XYZ Inc. is planning to bring a new product. They expect sales to be $200,000 with total fixed and variable costs representing 70% of sales. The discount rate on the unlevered equity is 17%. The firm plans to raise $77,820 of the initial $150,000 investment as 9% perpetual debt. The corporate tax rate is 34%. The target debt ratio is 0.3. Calculate the all-equity NPV and the levered NPV using flow-to-equity method.

Answer 1

1]	ALL EQUITY NPV:
	FCFF = 200000*(1-70%)*(1-34%) =	$             39,600
	All equity NPV = -150000+39600/0.17 =	$             82,941
2]	NPV of FLOW TO EQUITY:
	Levered perpetual cash flow = 39600 [as at (1)
	above]-77820*9%*(1-34%) =	$             34,977
	Initial investment = 150000-77820 =	$             72,180
	Cost of levered equity = 17%+(17%-9%)*(1-34%)*0.3/0.7 =	19.26%
	[Cost of levered equity = Cost of unlevered equity+[(Cost of levered equity-Cost of debt)*(1-t)*D/E]
	NPV of flow to equity = -72180+34977/19.26% =	$         1,09,424