AFM372 Study Guide - Midterm Guide: Dissociation Constant, Financial Market Participants, Underwriting
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Based on the attached spreadsheet (loosely based on the APV example in class), compute the following with a 34% tax rate:
(a) Firm value according to APV where the present value of the interest tax shield is computed using Pre-tax WACC, not the cost of debt. (10 points)
(b) Firm value according to CCF. (10 points)
The APV and CCF valuations will be identical. Note that depreciation, CAPEX, and change in NWC are all zero.
Interest Paid | $21.60 | $19.10 | $17.80 | $16.70 | $15.80 | ||
Free Cash Flows | |||||||
EBIT | $22.70 | $29.80 | $37.10 | $40.10 | $42.10 | ||
-Taxes | $7.72 | $10.13 | $12.61 | $13.63 | $14.31 | 34% tax r | |
= Unlevered Free Cash Flow | $14.98 | $19.67 | $24.49 | $26.47 | $27.79 | ||
Unlevered Cost of Equity | 13.50% | Pre-tax WACC or Return on Assets | |||||
Cost of Equity | 24.00% | ||||||
Cost of Debt | 9.50% | ||||||
Terminal Growth Rate | 0.00% |
Propel Corporation plans to make a $ 49.5 millionâ investment, initially funded completely with debt. The free cash flows of the investment andâ Propel's incremental debt from the project are shownâ here:â
Year | 0 | 1 | 2 | 3 |
Free Cash flows ($ million) | -49.5 | 39.6 | 21.8 | 24.8 |
Debt ($ million) | 49.5 | 31.6 | 13.9 | 0.0 |
Propel's incremental debt for the project will be paid off according to the predetermined schedule shown.â Propel's debt cost of capital is 7.4 %, and its tax rate is 35 %. Propel also estimates an unlevered cost of capital for the project of 12.6 %.
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 overâ time? Why?
c. Compute theâ 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 overâ time? Why?
e. Compute theâ project's equity value using the FTE method. How does the initial equity value compare with the NPV calculated in parts (aâ) and â(câ)?
Hintâ: Make sure to round all intermediate calculations to at least four decimal places.