Please see image of question. Consider the following project for your firm. An i

Question

Please see image of question.

Consider the following project for your firm. An initial investment of $1 million will generate expected unlevered pre-tax cash flows (UCF) of $300,000 per year in perpetuity. The firm will finance this project maintaining its capital structure with equal amounts of debt and equity. Three of your firm's closest competitors have unlevered betas of respectively 1.2, 1.3, and 1.4. These firms are approximately equal in size. The risk free rate is currently 5%, while the expected return on the S&P; 500 index is 14%. The corporate tax rate is 34%. The firm can borrow risk free. a. What is the average unlevered equity beta in the industry? b. What is the levered beta for the project? c. What is Re? d. What is Rwacc? e. What is the NPV of this project using Rwacc? f. How much will they borrow? g. What is the annual interest payment? h. What is the initial equity stake? 1. Use the Flow-to-Equity approach to value this project.

Explanation / Answer

ANSWERS

2. bE = (1 + 0.66 x 1) x 1.3 = 2.158

3.RE = 0.05 + 2.158 x (0.14 - 0.05) = 0.24422

4. RWACC = 0.5 x 0.66 x 0.05 + 0.5 x 0.24422

RWACC = 0.13861 = 13.861%

5. PV = UCF / RWACC =

$300,000 / 0.13861 = $2,164,346.01

NPV = $2,164,346.01 - $1 million =

$1.164,346.01

6. 0.5 x $2,164,346.01 = $1,082,173.00

7. 0.05 x $1,082,173.00 = $54,108.65

8 . $1 million - $1,082,173.00 = -$82,173.00

9.

Pre-tax earnings (EBIT): $300,000 / 0.66 =

$454,545.45

EBT = $454,545.45 - $54,108.65 =

$400,436.80

                After-tax earnings: 0.66 x $400,436.80 =

                $264,288.29 = Levered Cash Flow (LCF)

($264,288.29 / 0.24422) -(-$82,173.00) =

$1,164.346.00

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