Question

QUESTION 24

[Q24-35] Your firm’s market value balance sheet is given as follows:

Market Value Balance Sheet
Excess cash	$30M	Debt	$230M
Operating Assets	$500M	Equity	$300M
Asset Value	$530M	Debt + Equity	$530M

Assume that the you plan to keep the firm’s debt-to-equity ratio fixed. The firm’s corporate tax rate is 50%. The firm’s cost of debt is 10% and cost of equity is 20%.

Now, suppose that you are considering a new project that will last for one year. According to your analysis, free cash flows from the project are -$1,000 today (i.e. year 0) and $1,322.40 one year from today (i.e. year 1). This new project can be viewed as a “carbon copy” of the entire firm’s existing business. You want to find the NPV of the project using three different DCF methods: WACC/APV/FTE.

What is the firm’s WACC?

	A.	16%
	B.	14%
	C.	20%
	D.	10%

QUESTION 25

Under the WACC approach, the NPV of the project is obtained by discounting future ______ using the WACC.

	A.	Tax savings
	B.	Free cash flow to equity
	C.	Free cash flow to debt
	D.	Free cash flow

QUESTION 26

1. What is the NPV based on the WACC approach?

   	A.	$140
   	B.	$160
   	C.	$200
   	D.	$20

QUESTION 27

What is the firm’s unlevered cost of capital?

	A.	10%
	B.	20%
	C.	14%
	D.	16%

QUESTION 28

What is the NPV of the project if the project were financed by 100% equity (i.e. unlevered)?

	A.	$200
	B.	$140
	C.	$20
	D.	$160

QUESTION 29

The new project is financed with the same capital structure as the entire firm (implying that the interest tax shield should be discounted using the unlevered cost of capital). To do so, you raise $464 in debt at year 0. Then, what would the present value of the interest tax shield be? Assume that the interest rate on the debt is the same as the firm’s cost of debt (i.e. 10%).

	A.	$160
	B.	$20
	C.	$200
	D.	$140

Answer 1

Question 24

Kd: cost of debt = 10%

Ke = 20% (cost of common equity)

Total debt = $230m

Total equity = $300m

Total capital = $530m

Wd: % debt = 230/530 = 43.4%

We: % equity = 100%-43.4% = 56.6%

tax rate = 50%

WACC = We*Ke + (1 - tax rate)*Wd*Kd = 56.6%*20%+(1-50%)*43.4%*10% = 13.49%

Option B is correct

Question 25

FCF (free cash flow) = FCFF (free cash flow to firm)

Option D is correct

Question 26

NPV = -1000/(1+WACC)^0 + 1322.4/(1+WACC)^1 = -1000/(1+13.49%)^0+1322.4/(1+13.49%)^1 = $165.2128

Option B is correct

Question 27

Unlevered cost of capital = unlevered cost of equity = pre-tax wacc =  56.6%*20%+(1-0%)*43.4%*10% = 15.66%

Option D is correct