Question

QUESTION 24

[Q24-35] 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.

The prompt above is used to answer the following questions.

QUESTION 30

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

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

QUESTION 31

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

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

QUESTION 32

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

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

  

QUESTION 33

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

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

  

QUESTION 34

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

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

QUESTION 35

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

Yes

No

Please show work.

Answer 1

Ans 30) $140

Year	0	1	Remarks
PAT	-1000	1,322
PBT		2,645	PAT/Tax Rate
Interest		43	PAT at T0*230/530
New PBT		2,688	PBT + Interest
Tax @ 50%	(1,344)
PAT		1,344
PV of PAT @ 20%	1,120	PAT/(1+20%)
Tax Saving Calculation
Interest		43
Tax Savings on Interest	22
PV of tax savings @ 10%	20	Tax Savings/(1+20%)
Total NPV	140	PV of PAT @ 20% + PV of tax savings @ 10% -1000

Ans 31) - $536

FCFE at T0 = Equity + Debt

-1000 = Equity - 464

Equity = -536

Ans 32) $ 835.20

FCFF = 1300

Debt = 464

Equity = FCFF-Debt = 835.2

Ans 33) 20%

Ans 34) $ 140

FCFF under FTE approach = (1322/WACC - 1000)

WACC= Ke*Weight of Equity+Kd*Weight of Debt = 15.66%

Ans 35) Yes