Question

Suppose? Alcatel-Lucent has an equity cost of capital of 10.4 %?, market capitalization of $ 11.52 ?billion, and an enterprise value of $ 16 billion. Assume? Alcatel-Lucent's debt cost of capital is 6.1 %?, its marginal tax rate is 36 %?, the WACC is 8.58 %?, and it maintains a constant? debt-equity ratio. The firm has a project with average risk. Expected free cash? flow, debt? capacity, and interest payments are shown in the? table:

Year 0 1 2 3

FCF -100 51 103 67

D 52.27 42.47 17.28 0.00

Int 0.00 3.19 2.59 1.05

What is the free cash flow to equity for this? project? What is its NPV computed using the FTE? method? How does it compare with the NPV based on the WACC? method?

Answer 1

(i)	FTE =	FCF - Debt repayments
		(interest already adjusted in FCF)
	Discount rate to be used =			10.40%
				(Equity cost of capital)
	NPV Using FTE and cost of equity -
	Year	FCF	Debt	FTE	PV Factors @ 10.4%	PV of FTE
	0	-100	52.27	-152.27	1	-152.27
	1	51	42.47	8.53	0.905797	7.726449
	2	103	17.28	85.72	0.820468	70.33055
	3	67	0	67	0.743178	49.79292
						-24.4201
(ii)	NPV using WACC =
	Year	FCF	PV factor @ 8.58%	PV of FCF
	0	-100	1	-100
	1	51	0.92098	46.96998
	2	103	0.848204	87.36501
	3	67	0.781179	52.33898
				86.67397
	This means the project provides positive NPV but the sharesholders will still lose.