Question

# Your firm’s market value balance sheet is given as follows: Market Value Balance Sheet Excess cash...

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%

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)

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