Question

In: Finance

Your firm is considering a project with no start-up costs that will generate $1 million in...

Your firm is considering a project with no start-up costs that will generate $1 million in FCF forever, starting in one year. Your debt-to-equity ratio is 1, your equity-holders require a return of 12%, and your debt-holders require a return of 8%. The tax rate is 20%. Using the Adjusted Present Value method, compute the unlevered value of the project, the value of the tax shield (assuming you maintain your current leverage ratio), and the levered value of the project.

a. V_u = $10 million, PV(Tax Shield) = $0.870 million, V_L = $10.870 million

b. V_u = $12 million, PV(Tax Shield) = $0.080 million, V_L = $12.080million

c. V_u = $10 million, PV(Tax Shield) = $1.740 million, V_L = $11.740 million

d. V_u = $11.740 million, PV(Tax Shield) = $0, V_L = $11.740 million

Solutions

Expert Solution

Hence, the correct answer is the first option i.e. option a. V_u = $10 million, PV(Tax Shield) = $0.870 million, V_L = $10.870 million

D/E = 1

Wd = D/(D + E) = 1 / (1 + 1) = 0.5

We = 1 - Wd = 0.5

Cost of equity for the unlevered firm, r = Wd x Kd + We x Ke = 0.5 x 8% + 0.5 x 12% = 10%

Hence, value of the unlevered firm = C/r = 1/10% = $ 10 million.

Let V be the value fo the levered firm. Then D = V x Wd = V x 50% = 0.5V

Interest = Kd x D = 8% x 0.5V = 0.04V

Interest tax shield = ITS = Interest x T = 0.04V x 20% = 0.008V

PV of ITS = ITS / r = 0.008V/10% = 0.08V

Also Value of the levered firm = Value of unlevered firm + PV of ITS

Hence, V = 10 + 0.08V

Hence, V = 10 / (1 - 0.08) = 10.870

and PV of ITS = 0.08V = 0.08 x 10.870 = 0.870

Hence, the correct answer is the first option i.e. option a. V_u = $10 million, PV(Tax Shield) = $0.870 million, V_L = $10.870 million

jeff jeffy answered 2 years ago
Next > < Previous

Related Solutions

Your firm is considering a project that will cost $ 4.548$4.548 million up​ front, generate cash...
Your firm is considering a project that will cost $ 4.548$4.548 million up​ front, generate cash flows of $ 3.50$3.50 million per year for 33 ​years, and then have a cleanup and shutdown cost of $ 6.00$6.00 million in the fourth year. a. How many IRRs does this project​ have? b. Calculate a modified IRR for this project assuming a discount and compounding rate of 10.0 %10.0%. c. Using the MIRR and a cost of capital of 10.0 %10.0%​, would...
4) Your company is considering a project that will generate sales revenue of $90 million in...
4) Your company is considering a project that will generate sales revenue of $90 million in Year 1. Revenue is expected to be flat for subsequent years. The project requires working capital equal to 16% of sales revenue, and has total operating costs excluding depreciation equal to 50% of sales. The equipment has a 3 year MACRS life and can be purchased and installed for $100 million. The project will end in three years. At that time, the equipment can...
Your firm is considering a project with a discount rate of 10%. If you start the...
Your firm is considering a project with a discount rate of 10%. If you start the project today, your firm will incur an initial cost of $480 and will receive cash inflows of $300 per year for 3 years with the first cashflow occurring one year from today. If you instead wait one year to start the project, the initial cost will rise to $520 and the cash flows will increase to $350 a year for the following 3 years...
A firm has an investment project that will cost the firm $30 million but will generate...
A firm has an investment project that will cost the firm $30 million but will generate $2 million of NPV. Also there is a 5% chance that the firm will lose a lawsuit to employees, and be forced to pay damage of $30 million. Suppose that a liability insurance policy with a $30 million limit has a premium equal to $1.5 million. a. Compute expected claim cost b. Compute the amount of loading on the policy c. Compute the expected...
A firm has an investment project that will cost the firm $30 million but will generate...
A firm has an investment project that will cost the firm $30 million but will generate $2 million of NPV. Also there is a 5% chance that the firm will lose a lawsuit to employees, and be forced to pay damage of $30 million. Suppose that a liability insurance policy with a $30 million limit has a premium equal to $1.5 million. Compute expected claim cost Compute the amount of loading on the policy Compute the expected cost of not...
Your firm is considering a project that will cost $3 million in initial investments. The project...
Your firm is considering a project that will cost $3 million in initial investments. The project will earn cash flows of $750,000 for 6 years then terminate with no salvage value. If the WACC is 8%, what is the Net Present Value of the investment? $467,160 $487,993 $472,627 $503,679 A project calls for $5.5 million in initial investments. The project will return the following cash flows. What is the modified IRR if the WACC of 7% is applied as the...
Your company is considering a capital investment of ​$212.469 million. The project will generate equal annual​...
Your company is considering a capital investment of ​$212.469 million. The project will generate equal annual​ after-tax operating cash flows of ​$36.79 million for 7 years. At the end of its​ life, the project will be sold for ​$37 ​million, but the​ project's adjusted tax basis at termination will be ​$31 million. The project will require ​$16 million in additonal net working capital. With a 27​% marginal tax​ rate, what is the​ project's IRR? ​ (Percent with​ 1decimal)
Bourque Enterprises is considering a new project. The project will generate sales of $1.7 million, $2.4...
Bourque Enterprises is considering a new project. The project will generate sales of $1.7 million, $2.4 million, $2.3 million, and $1.8 million over the next four years, respectively. The fixed assets required for the project will cost $2.7 million and will be eligible for 100 percent bonus depreciation. At the end of the project, the fixed assets can be sold for $185,000. Variable costs will be 25 percent of sales and fixed costs will be $475,000 per year. The project...
Bourque Enterprises is considering a new project. The project will generate sales of $1.3 million, $1.8...
Bourque Enterprises is considering a new project. The project will generate sales of $1.3 million, $1.8 million, $1.7 million, and $1.2 million over the next four years, respectively. The fixed assets required for the project will cost $1.7 million and will be eligible for 100 percent bonus depreciation. At the end of the project, the fixed assets can be sold for $185,000. Variable costs will be 20 percent of sales and fixed costs will be $440,000 per year. The project...
Bourque Enterprises is considering a new project. The project will generate sales of $1.6 million, $2...
Bourque Enterprises is considering a new project. The project will generate sales of $1.6 million, $2 million, $1.9 million, and $1.4 million over the next four years, respectively. The fixed assets required for the project will cost $1.5 million and will be eligible for 100 percent bonus depreciation. At the end of the project, the fixed assets can be sold for $175,000. Variable costs will be 30 percent of sales and fixed costs will be $400,000 per year. The project...
ADVERTISEMENT
Subjects
ADVERTISEMENT
Latest Questions
ADVERTISEMENT