1. [15 points] ABC Corp. is considering expansion of its production capacity by
ID: 2753493 • Letter: 1
Question
1. [15 points] ABC Corp. is considering expansion of its production capacity by investing in a project with the following unlevered cash flows (UCF): Year 0: -$30 million Year 1: +$10 million Year 2: +$8 million Year 3 and all future years: +$5 million ABC Corp. will finance this expansion both with internal cash and by selling $10 million in bonds. The bonds pay interest of 10%. Although the current expected return on ABC’s stock is not known, it is known that the expected return on its stock would be 15% if the firm did not have any debt. The firm is expected to maintain a current debt-equity ratio of 1/2 for the foreseeable future. The corporate income tax rate is 30%. Ignoring the costs of financial distress and issue costs, calculate the net present value of this project using the Flow-To-Equity (FTE) approach.
Explanation / Answer
Answer: Calculation of the WACC:
WACC=Wd*Kd+We*Ke
=0.50*10%(1-0.30)+0.50*15%
=11%
Discount rate 11% Year UCF 0 -30 1 10 2 8 3 5 3 45.45 Price=5/0.11 NPV 19.09726816Related Questions
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