Question

You are a consultant who has been hired to evaluate a new product line for Markum Enterprises. The upfront investment required to launch the product line is $ 7 million. The product will generate free cash flow of $ 0.70 million the first​ year, and this free cash flow is expected to grow at a rate of 5 % per year. Markum has an equity cost of capital of 11.2 %​, a debt cost of capital of 7.18 %​, and a tax rate of 42 %. Markum maintains a​ debt-equity ratio of 0.60. a. What is the NPV of the new product line​ (including any tax shields from​ leverage)? b. How much debt will Markum initially take on as a result of launching this product​ line? c. How much of the product​ line's value is attributable to the present value of interest tax​ shields? TWO DECIMALS

Answer 1

a)

Computation of NPV of new product line:

b)

Computation of debt:

c)

Computation of amount of product line's value is attributable to PV of interest tax shield:

Note : Discounting at will give the unlevered value.