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njashfanantenana asked for the first time
in Finance·
1 Jun 2024

Your firm is considering a new three-year project. You know that the

unlevered cost of equity for firms with a similar risk as your target is 8%. At the end of the

project, all available funds are distributed to equity and debt holders. Use the following

financial statements to answer the questions on the next page:

 

Year

0

1

2

3

Income statement

 

 

 

 

Sales

 

$175,000

$175,000

$175,000

COGS

 

$26,250

$26,250

$26,250

Depreciation

 

$100,000

$100,000

$100,000

EBIT

 

$48,750

$48,750

$48,750

Interest payment on debt

 

$9,000

$9,000

$9,000

Profit Before tax

 

$39,750

$39,750

$39,750

Taxes

 

$21,863

$21,863

$21,863

Profit after tax

 

$17,888

$17,888

$17,888

Dividends

 

$17,888

$17,888

$17,888

Retained earnings

 

$0

$0

$0

 

Balance Sheet

 

 

 

 

Cash and Mark. Sec.

$0

$100,000

$200,000

$300,000

Current Assets

$0

$0

$0

$0

Fixed Assets

 

 

 

 

   At cost

$300,000

$300,000

$300,000

$300,000

   Acc. Depreciation

$0

$100,000

$200,000

$300,000

   Net Fixed Assets

$300,000

$200,000

$100,000

$0

Total Assets

$300,000

$300,000

$300,000

$300,000

 

 

 

 

 

Current liabilities

$0

$0

$0

$0

Debt

$150,000

$150,000

$150,000

$150,000

Stock

$150,000

$150,000

$150,000

$150,000

Acc. Ret. Earn.

$0

$0

$0

$0

Total liab.and equity

$300,000

$300,000

$300,000

$300,000

 

  1. a) How large an equity investment does the project require upfront?

 

  1. b) How much equity is recovered at the end of the project?

 

  1. c) Show the cash to and from equity holders for the entire project. Don’t forget

about dividends, initial, and terminal equity flows. Actual cash, not free cash flow!

 

Year

0

1

2

3

Total cash flows to equity

 

 

 

 

 

 

  1. d) Based on the cash flows in part c, what is the IRR for the equity holders?

 

 

  1. e) What is the present value of the tax shield for this three-year project?

Remember, this is not a perpetuity, it’s a three-year project.

 

  1. f) Is this a good project for shareholders?

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