Question

6) Suppose​ Alcatel-Lucent has an equity cost of capital of 10%​, market capitalization of $10.80 ​billion, and an enterprise value of $14.4 billion. Suppose​ Alcatel-Lucent's debt cost of capital is 6.1% and its marginal tax rate is 35%.

a. What is​ Alcatel-Lucent's WACC?

b. If​ Alcatel-Lucent maintains a constant​ debt-equity ratio, what is the value of a project with average risk and the expected free cash flows as shown​ here,

Year 0, 1, 2, 3

FCF ($ million) -100, 50, 100, 70

c. If​ Alcatel-Lucent maintains its​ debt-equity ratio, what is the debt capacity of the project in part ​(b​)?

Answer 1

a). WACC = [wD x kD x (1 - t)] + [wE x kE]

= [{(14.4 - 10.8)/14.4} x 6.1% x (1 - 0.35)] + [(10.8/14.4) x 10%] = 0.99% + 7.50% = 8.49%

b). NPV = PV of Cash Inflows - PV of Cash Outflows

= [(50/1.0849) + (100/1.0849²) + (70/1.0849³) - 100

= 46.09 + 84.96 + 54.82 - 100 = $85.86 million

c). d = [14.4 - 10.8] / 14.4 = 0.25

The project’s debt capacity is equal to d times the levered value of its remaining cash flows at each date.

Year	0	1	2	3
FCF	-100	50	100	70
VL	185.86	151.64	64.52	0
D = d*VL	46.47	37.91	16.13	0.00