Question

Your company has an equity cost of capital of 10%, debt cost of capital of 6%, market capitalization of $10B, and an enterprise value of $14B. Your company pays a corporate tax rate of 35%. Your companymaintains a constant debt-to-equity ratio.

a)What is the (net) debt value of your company? (Hint:Net debt = D–Excess cash)
b)What is the(net)debt-to-equity ratio of your company?
c)What is the unlevered cost of capital of your company?(Hint:When a firm has a target leverageratio, its unlevered cost of capital is equal to the pretax WACC = D/(D+E) E[rD] + E/(D+E) E[rE]
d)What is WACC with taxes of your company?

Your company is considering a new project. The project costs $100M in year 0, generates free cash flows over the next three years, and becomes obsolete afterwards. The expected after-tax free cash flows from the project are summarized in the table below:

Year	0	1	2	3
FCF in $M	-100	50	100	70

The new project has the same market risk as the company. Your company will maintain the same debt-to equity ratio for the new project.
e) What is the unlevered value of the new project? (Hint: Do NOT include year 0 FCF in this calculation.)
f) What is the levered value of the new project? (Hint: Do NOT include year 0 FCF in this calculation.)
g) What is the total NPV of the project including the NPV of the financing?

Answer 1

(a) Enterprise Value = Market Capitalization + Debt - Cash = Market Capitalization + Net Debt

Enterprise Value = $ 14 B and MArket Capitalization = $ 10 B

Net Debt = Enterprise Value - Market Capitalization = 14 - 10 = $ 4 B

(b) Net Debt to Equity Ratio = Net Debt / Market Capitalization = 4 / 10 = 2/5

(c) Cost of Debt = 6 % = kd and Cost of Equity = ke = 10 %

Unlevered Cost of Capital = 6 x (2/2+5) + 10 x (5/2+5) = 8.857143 % ~ 8.86 %

(d) Tax Rate = 35 %

WACC = kd x (1-Tax Rate) x (D/D+E) + ke x (E/D+E) = 6 x (1-0.35) x (2/7) + 10 x (5/7) = 8.257143 % ~ 8.26 %

NOTE: Please raise a separate query for the solution to the remaining unrelated question, as one query is restricted to the solution of only one complete question with a maximum of four sub-parts.