Hello, does the following question have too much info because it has confused me
ID: 2647572 • Letter: H
Question
Hello, does the following question have too much info because it has confused me, please help. Ty in advance
New Line Cinema is embarking in a new project, and it has the following ratios, a debt to value ratio of 25%, an equity cost of capital of 15%,A debt cost of Capital 4% and a marginal tax rate of 25%. the firm projects the following free cash flows for years 0, 1,and 2 of -50,60,60 respectively.
Suppose they use debt in the following schedule to fund the project, year 0, $20 million of debt.year 1 $10 million of debt, adn year 2 $0 debt. What is the levered value of the project?
Explanation / Answer
New line Cinema (new project)
Total Debt (D)= $20 million + $10 million + $ 0 = $ 30 million
Debt to value ratio = Debt/ value of project
25% = $ 30,000,000/value of project
Value of the project = 120,000,000
Value of the equity (E) = $ 120 million-$30 million = $ 90 million
Debt cost of capital (Kd) = 4%
Marginal tax rate (t) = 25%
Equity cost of capital (Ke) = 15%
Weighted Avg. Cost of capital = Ke (E/E+D) + Kd (1-t) (D/E+D)
=15%(90/90+30) + 4% (1-0.25) (30/90+30)
= 15% (0.75) + 4% (0.75)(0.25)
= 11.25% + 0.75%
=12%
(Figures in $ million)
Year
Cash flows
Discount rate = WACC=12%
Cash flows
0
-50
1
1
-50.00
1
60
1/1.12
0.8928571
53.57
2
60
1/(1.12)2
0.7971939
47.83
Net Present value
51.40
(Figures in $ million)
Year
Debt
Interest
Interest tax shield
Discount rate
Cash flows
4%
Interest * tax rate
WACC=12%
0
0
0.00
0
1
0.00
1
20
0.80
0.2
0.892857143
0.18
2
30
1.20
0.3
0.797193878
0.24
Total
0.42
Levered value of the firm = NPV of project+ present value of Interest tax shield
= $ 51.40 million +$ 0.42 million
=$ 51.82 million
Year
Cash flows
Discount rate = WACC=12%
Cash flows
0
-50
1
1
-50.00
1
60
1/1.12
0.8928571
53.57
2
60
1/(1.12)2
0.7971939
47.83
Net Present value
51.40
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