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. | |||||||

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