Question

QUESTION 76

For the next 8 questions suppose the following data.

The Also Horns Corp. is planning on introducing a new line of saxophones. They expect sales to be $400,000 with total fixed and variable costs representing 70% of sales. The discounted rate of the unlevered equity is 17%, but the firm plans to raise $144,385 of the initial $450,000 investment as 9% perpetual debt. The corporate tax rate is 40% and the target debt to asset (or value) ratio is 0.3.

In addition to the information above, suppose the APV approach is used to evaluate the project for the next 4 questions.

How much is the unlevered cash flow?

		$72,000
		$84,000
		$100,000
		$120,000
		$144,000

1 points   

QUESTION 77

What is the NPV of the project to an all-equity firm?

		$-34,451
		$-26,471
		$-12,417
		$25,376
		$34,451

1 points   

QUESTION 78

What is the NPV of the financing side effects (NPVF)?

		$44,334
		$57,754
		$62,250
		$65,000
		$75,250

1 points   

QUESTION 79

What is the APV of the project?

		$12,341
		$27,799
		$31,283
		$35,779
		$45,337

1 points   

QUESTION 80

Suppose the FTE approach is used to evaluate the project for the next 3 questions.
Use the information in Problem 76,

How much is the levered cash flow?

		$42,250
		$48,000
		$55,236
		$64,203
		$70,520

1 points   

QUESTION 81

What is the rS, discount rate for the equity of the levered firm?

		16.25%
		18.14%
		19.06%
		19.67%
		20.20%

1 points   

QUESTION 82

What is the Initial Net Equity Investment?

		$200,000
		$225,500
		$250,500
		$275,500
		$305,615

Answer 1

Unlevered Cash Flows : 400000 * (1-70%) = 120000. Taxes = 40%; Net of Tax cash flows = 72000

NPV : -450000 + 72000/(1+17%) = -26471

Financing benefit : NPV (terminal value) interest tax shield = Tax rate * debt = 40% 144385 (since the debt is given as perpetual debt). = 57754

APV = 57754 - 26471 = 31283

FTE approach :

Cash flow to equity holders : [400000 * (1-70%) - 144385 * 9% ] * (1-40%) = 64203

R_s = unlevered cost of equity + Debt / Equity * (1- tax rate) * (unlevered equity rate - debt cost)

R_s = 17% + 0.3/0.7 * (1-40%) * (17%-9%) = 19.06% (we have used 0.3 as debt to asset ratio hence d/e would be 0.3/0.7)

Initial Net Equity = 450000 - 144385 = 305615