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 NPV of the project based on the APV approach?

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

QUESTION 2

What is the FCFE at year 0? (Hint: You raise $464 in debt at time 0.)

	A.	$835.20
	B.	$536
	C.	-$536
	D.	-$835.20

QUESTION 3

What is the FCFE at year 1? (Hint: You repay the debt of $464 at time 1.)

	A.	$835.20
	B.	-$536
	C.	-$835.20
	D.	$536

QUESTION 4

Which of the following serves as the discount rate for free cash flows to equity?

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

QUESTION 5

What is the NPV of the project based on the FTE approach?

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

QUESTION 6

Do the WACC/APV/FTE approaches produce identical NPV values?

Yes

No

Answer 1

QUESTION 1) What is the NPV of the project based on the APV approach?

Adjusted Present Value = Unlevered Firm Value + Net effect of debt

NPV = -1000 + 1322.4 / (1+ WACC) - 230 = -1000+1146.86-230 = -64.787

WACC = Ke* E/(D+E) + Kd * D * (1-T) /(D+E) = 0.2 *300/(230+300) + 0.1 * 230 * (1-0.5) / (230/300) = 0.1132 + 0.0217 = 0.1349

QUESTION 2) What is the FCFE at year 0?

FCFE = FCFF + Net Borrowing - Interest * (1-t)

FCFE = (-1000)+230-0.1*230*(1-0.5) = -1000+230-11.5= -781.5

QUESTION 3) What is the FCFE at year 1?

FCFE = FCFF + Net Borrowing - Interest * (1-t)

FCFE = 1322.4+230-0.1*230*(1-0.5) = 1322.4+230-11.5= 1540.9

QUESTION 4) Which of the following serves as the discount rate for free cash flows to equity?

Cost of Equity is 20%. Therefore it will act a discount rate.

QUESTION 5) What is the NPV of the project based on the FTE approach?

NPV = -1000 +1322.40 (1+0.1349) = 165.21

QUESTION 6) Do the WACC/APV/FTE approaches produce identical NPV values?

NO