Question

Suppose​ Alcatel-Lucent has an equity cost of capital of 10.7 %,market capitalization of$ 10.50 ​billion, and an enterprise value of $15

billion. Suppose​ Alcatel-Lucent's debt cost of capital is 7.2 % and its marginal tax rate is 34 %

a. What is​ Alcatel-Lucent's WACC?

b. If​ Alcatel-Lucent maintains a constant​ debt-equity ratio, what is the value of a project with average risk and the expected free cash flows as shown​ here,

Year 0 1 2 3
FCF ($ million)   -100   52   104   72

c. If​ Alcatel-Lucent maintains its​ debt-equity ratio, what is the debt capacity of the project in part ​(b​)?

Answer 1

Solution :-

(a)

After tax Cost of Debt = 7.2% * ( 1 - 0.34 ) = 4.752%

Cost of Equity = 10.7%

Equity Weight = $10.50 / $15 = 70%

Debt Weight = 1 - 0.70 = 0.30 = 30%

Now WACC = ( 4.752% * 0.30 ) + ( 10.7% * 0.70 )

= 8.92%

(b) Value = Present Value of Cash Inflows - Initial Cost

= [ $52 / ( 1 + 0.0892 ) ] + [ $104 / ( 1 + 0.0892 )² ] + [ $72 / ( 1 + 0.0892 )³ ] - $100

= $191.14 - $100

= $91.14

(C)

Now Present Value of Cash flows

At Year 0 = [ $52 / ( 1 + 0.0892 ) ] + [ $104 / ( 1 + 0.0892 )² ] + [ $72 / ( 1 + 0.0892 )³ ]

= $191.14

At Year 1 =    [ $104 / ( 1 + 0.0892 ) ] + [ $72 / ( 1 + 0.0892 )² ]

= $156.182

At Year 2 =  [ $72 / ( 1 + 0.0892 ) ]

= $66.12

Now Debt Capacity Wd = VL* Weight of Debt

Year 0 = $191.14 * 30% = $57.342

Year 1 = $156.182 * 30% = $46.85

Year 2 = $66.12 * 30% = $19.83

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