Question 24
[Q2435] 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 debttoequity 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.
What is the NPV of the project if the project were financed by 100% equity (i.e. unlevered)?
A. 
$20 

B. 
$200 

C. 
$160 

D. 
$140 
Answer : Option C). $160.
Explanation : Weight of debt = Debt / (Debt + Equity) = 230 / 530 = 0.43 (approx).
Weight of equity = Equity / (Debt + Equity) = 300 / 530 = 0.57 (approx).
Weighted average cost of capital (WACC) = Weight of debt * Cost of debt (after tax) + Weight of equity * Cost of equity
= 0.43 * 10 % * (1  0.50) + 0.57 * 20 %
= 0.43 * 5 % + 0.57 * 20 %
= 2.15 % + 11.4 %
= 13.55 % (Rounded off to 14 % Or 0.14).
Present value of cash inflow = Future cash inflow / (1 + WACC)
= 1322.40 / (1 + 0.14)
= 1322.40 / 1.14
= $ 1160.
Present value of cash outflow = $ 1000. (Given in the question).
NPV (Net present value of project) = Present value of cash inflow  Present value of cash outflow.
= 1160  1000
= $ 160. (Option C).
Conclusion : NPV of project = $ 160. (Option C).
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