Question

**(1)You are thinking of starting a new project. You do a
cash-flow analysis and estimate that the project will give you a
free cash flow of $50M in one year and the free cash flows will
grow at a rate of 2% per year perpetually.**

**The equity beta for a firm
similar to your proposed project is 1.4. This similar firm has
$300M of risk-free debt outstanding and has 300 million shares,
each valued at $5 each. It also has a target leverage ratio (fixed
D/V) policy.**

**Your firm has a target
debt-to-equity ratio of 0.5 and your debt is risk free. Assume that
the risk-free rate is 6%, that the market risk premium is 8.4% and
that the corporate tax rate is 34%.**

**Determine how much your
project is worth using the WACC approach.**

**(2)True or False:**
**For a US firm financed by both debt and equity, the
before-tax cost of debt is the same as the after-tax cost of debt
for firms making zero taxable income. Briefly explain for your
answer.**

Answer #1

1] | The first step is to find the unlevered equity beta. | ||

Unlevered equity beta = 1.4/(1+0.66*1/5) = | 1.24 | ||

[D/E ratio = 300/(300*5) | |||

Relevering equity beta to target debt-equity ratio = 1.24*(1+0.66*0.5) = | 1.65 | ||

After tax cost of debt = 6%*(1-34%) = | 3.96% | ||

Cost of equity per CAPM = 6%+1.65*8.4% = | 19.86% | ||

WACC = 3.96%*0.5/1.5+19.86%*1/1.5 = | 14.56% | ||

Worth of the project = 50/(0.1456-0.02) = | $ 398.09 | Million | |

2] | True. | ||

After tax cost of debt = Before tax cost of debt*(1-tax rate) | |||

When taxable income is 0, the after tax cost of debt is the | |||

same as the before tax cost of debt. |

Blue Angel, Inc., a private firm in the holiday gift industry,
is considering a new project. The company currently has a target
debt–equity ratio of .30, but the industry target debt–equity ratio
is .25. The industry average beta is 1.40. The market risk premium
is 8 percent, and the risk-free rate is 6 percent. Assume all
companies in this industry can issue debt at the risk-free rate.
The corporate tax rate is 35 percent. The project requires an
initial outlay...

Suppose that your
company is launching a new project. To estimate the cost of capital
for the project
you search the market and find
a company that has very similar risk characteristics to the project
as follows:
Market capitalization, MVE =
$100.00
million
Market value of debt, D =
$50.00
million
Cost of debt, Rd =
5.00%
Cost of equity, Re =
15.50%
Corporate tax rate, t =
30%
Calculate the cost of capital
of the project for the following...

Blue Angel, Inc., a private firm in the holiday gift industry,
is considering a new project. The company currently has a target
debt–equity ratio of .30, but the industry target debt–equity ratio
is .25. The industry average beta is 1.40. The market risk premium
is 8 percent, and the risk-free rate is 6 percent. Assume all
companies in this industry can issue debt at the risk-free rate.
The corporate tax rate is 35 percent. The project requires an
initial outlay...

Blue Angel, Inc., a private firm in the holiday gift industry,
is considering a new project. The company currently has a target
debt–equity ratio of .45, but the industry target debt–equity ratio
is .40. The industry average beta is 1.30. The market risk premium
is 7 percent, and the risk-free rate is 5 percent. Assume all
companies in this industry can issue debt at the risk-free rate.
The corporate tax rate is 34 percent. The project requires an
initial outlay...

Blue Angel, Inc., a private firm in the holiday gift industry,
is considering a new project. The company currently has a target
debt-equity ratio of .40, but the industry target debt-equity ratio
is .45. The industry average beta is 1.20. The market risk premium
is 6.8 percent and the risk-free rate is 4.4 percent. Assume all
companies in this industry can issue debt at the risk-free rate.
The corporate tax rate is 22 percent. The project requires an
initial outlay...

Blue Angel, Inc., a private firm in the holiday gift industry,
is considering a new project. The company currently has a target
debt-equity ratio of .70, but the industry target debt-equity ratio
is .75. The industry average beta is 1.10. The market risk premium
is 6.5 percent and the risk-free rate is 4.5 percent. Assume all
companies in this industry can issue debt at the risk-free rate.
The corporate tax rate is 21 percent. The project requires an
initial outlay...

Blue Angel, Inc., a private firm in the holiday gift industry,
is considering a new project. The company currently has a target
debt–equity ratio of .40, but the industry target debt–equity ratio
is .35. The industry average beta is 1.20. The market risk premium
is 8 percent, and the risk-free rate is 6 percent. Assume all
companies in this industry can issue debt at the risk-free rate.
The corporate tax rate is 40 percent. The project requires an
initial outlay...

Blue Angel, Inc., a private firm in the holiday gift industry,
is considering a new project. The company currently has a target
debt-equity ratio of .35, but the industry target debt-equity ratio
is .30. The industry average beta is 1.15. The market risk premium
is 6.3 percent and the risk-free rate is 3.9 percent. Assume all
companies in this industry can issue debt at the risk-free rate.
The corporate tax rate is 22 percent. The project requires an
initial outlay...

Doubleday Brewery is considering a new project.
The company currently has a target debt–equity ratio of .40, but
the industry target debt–equity ratio is .25. The industry average
beta is 1.08. The market risk premium is 8 percent, and the
(systematic) risk-free rate is 2.4 percent.
Assume all companies in this industry can issue debt at the
risk-free rate. The corporate tax rate is 21 percent. The project
will be financed at Doubleday’s target debt–equity ratio. The
project requires an...

8. An all-equity firm is considering financing its next
investment project with a combination of equity and debt. The asset
beta for the firm as a whole is 1.2 (recall that this is the same
as the equity beta for an all-equity firm, but not the same as the
equity beta for a “levered” firm). Assume the average rate of
return on the market is 6% and the risk-free rate is 1%. The cost
of debt for the company is...

ADVERTISEMENT

Get Answers For Free

Most questions answered within 1 hours.

ADVERTISEMENT

asked 11 minutes ago

asked 11 minutes ago

asked 22 minutes ago

asked 34 minutes ago

asked 35 minutes ago

asked 36 minutes ago

asked 40 minutes ago

asked 42 minutes ago

asked 52 minutes ago

asked 54 minutes ago

asked 55 minutes ago

asked 1 hour ago