Question

In: Accounting

QUESTION 24 [Q24-35] Your firm’s market value balance sheet is given as follows: Market Value Balance...

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.

Solutions

Expert Solution

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


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