Question

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.

QUESTION 1

What is the firm’s WACC?

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

QUESTION 2

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

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

QUESTION 3

What is the NPV based on the WACC approach?

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

QUESTION 4

What is the firm’s unlevered cost of capital?

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

Answer 1

Q1.

Please refer to the calculations in screenshot below:

Q2.

Option D: Future Free cash flows are used for calculation of NPV after discounting them with WACC.

Q3.

Please refer to the calculations in screenshot below:

So the NPV is $160

Q4.

The cost of capital of unlevered firm will be same as the cost of equity = 20% (Option D)