Question

Propel Corporation plans to make a $ 51.2 million​ investment, initially funded completely with debt. The free cash flows of the investment and​ Propel's incremental debt from the project are shown​ here:

Year	0		1	2	3
Free cash flows​ ($ million)	−51.2		39.9	19.5	24.9
Debt​ ($ million)	51.2		28.1	15.4	0.0

​Propel's incremental debt for the project will be paid off according to the predetermined schedule shown.​ Propel's debt cost of capital is 8.3%, and its tax rate is 39%.

Propel also estimates an unlevered cost of capital for the project of 12.9%.

a. Use the APV method to determine the levered value of the project at each date and its initial NPV.

b. Calculate the WACC for this project at each date. How does the WACC change over​ time? Why?

c. Compute the​ project's NPV using the WACC method.

d. Compute the equity cost of capital for this project at each date. How does the equity cost of capital change over​ time? Why?

e. Compute the​ project's equity value using the FTE method. How does the initial equity value compare with the NPV calculated in parts

​(a​) and (c​)?

Hint​:

Make sure to round all intermediate calculations to at least four decimal places.

Answer 1

As the user has asked for Ans (a) and (c) only. Please find the answers and attached excel below:

PART (A)

Adjusted Present Value (APV) = Unlevered Firm Value + Net effect of debt​

The APV method to calculate the levered value of a project consists of three steps:

1. Calculate the unlevered value of project. To do this, discount the stream of FCFs by the unlevered cost of capital.

2. Calculate the net value of the debt financing.

3. Sum up the value of the unlevered project and the net value of debt financing to find the adjusted present value of the project.

	Amount in (million $) - Propel Corporation
	Year	0	1	2	3
	FCF	-51.2	39.9	19.5	24.9
	Debt	51.2	28.1	15.4	0
	Unlevered Cost of Capital (Ke)				12.90%
	Present Value @ Discount Rate 12.90%		35.34	15.30	17.30
Step 1	NPV of unlevered Project				$ 16.74
	Total Debt Amount				51.2
	Pre Tax Cost of Debt				8.30%
	Tax Rate				39%
	Post Tax Cost of Debt (Kd)				5.06%
Step 2	Present Value of Debt Financing				$ 51.20
Step 3	Value of Levered Project				$ 67.94

PART (C)

NPV = Today’s value of the expected future cash flows – Today’s value of invested money

WACC=E/V​∗Ke+D/V​∗Kd∗(1−T)

The in-built excel formula NPV takes two arguments, the discounting rate (WACC), and the series of cashflows from year 1 to the year 3

WACC Value		6.99%
NPV using WACC		$ 74.65