Question

Suppose​ Alcatel-Lucent has an equity cost of capital of 10.9 %​, market capitalization of $ 11.52 billion, and an enterprise value of $ 16 billion. Suppose​ Alcatel-Lucent's debt cost of capital is 7.4 % and its marginal tax rate is 37 %.

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?

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

​(b​)?

The debt capacity of the project in part​(b​) is as​ follows:

Answer 1

Answer :

(a.) Calculation of WACC :

WACC = (Cost of Equity * Weight of Equity) + (Cost of Debt * Weight of Debt)

Weight of Equity = Market capitalization / Enterprise Value

= 11.52 / 16

= 0.72 or 72%

Weight of Debt = (Enterprise value - Market Capitalization) / Enterprise value

= (16 - 11.52) / 16

= 0.28 or 28%

WACC = [10.9% * 0.72] + [7.4% * (1 - 0.37) * 0.28]

= 7.848% + 1.30536%

= 9.15336% or 9.15%

(b.) Assuming Cash Flows in year 0 ,1,2 and 3 is -100,53,104,75 respectively :

Value of Levered Project = [Cash Flow in year 1 / (1 + 0.0915)^1] + [Cash Flow in year 2 / (1 + 0.0915)^2] + [Cash Flow in year 3 / (1 + 0.0915)^3]

= [53 / (1 + 0.0915)^1] + [104 / (1 + 0.0915)^2] + [75 / (1 + 0.0915)^3]

= 48.5570316075 + 87.2942944567 + 57.6753240442

= 193.526650108

Value of Project = 193.526650108 - 100

= 93.52665 million

(c.) Debt capacity = Debt ratio * levered value of remainig cash flows

Debt Ratio = (Enterprise value - Market Capitalization) / Enterprise value

= (16 - 11.52) / 16

= 0.28 or 28%

	0	1	2	3
Cash Flows	-100	53	104	75
Levered value of Remainig Cash Flows	93.52665	158.234338594#	68.7127805767*	0
Debt capacity	26.19	44.31	19.24	0

# Levered value of remainig cash flows = [Cash Flow in year 2 / (1 + 0.0915)^1] + [Cash Flow in year 3 / (1 + 0.0915)^2]

= [104 / (1 + 0.0915)^1] + [75 / (1 + 0.0915)^2]

= 95.2817223997 + 62.9526161947

= 158.234338594

* Levered value of remainig cash flows = [Cash Flow in year 3 / (1 + 0.0915)^1]

= [75 / (1 + 0.0915)^1]

= 68.7127805767

= 158.234338594