Suppose Alcatel-Lucent has an equity cost of capital of 10.1%, market capitaliza
ID: 2800105 • Letter: S
Question
Suppose Alcatel-Lucent has an equity cost of capital of 10.1%, market capitalization of $12.48 billion, and an enterprise value of $16 billion. Assume Alcatel-Lucent's debt cost of capital is 6.8 %6.8%, its marginal tax rate is 36%, the WACC is 8.84%, and it maintains a constant debt-equity ratio. The firm has a project with average risk. Expected free cash flow, debt capacity, and interest payments are shown in the table:
Year 0 1 2 3
__________________________________________
FCF ($ million) -100 52 95 70
D=d*VL 40.10 32.10 14.15 0.00
interest 0.00 2.73 2.19 0.96
a. What is the free cash flow to equity for this project?
The free cash flow to equity for this project is: (Round all answers to two decimal places. Use a minus sign to indicate a negative number.)
Year
0
1
2
3
FCFE ($ million)
_____
_____
_____
_____
b. What is its NPV computed using the FTE method? How does it compare with the NPV based on the WACC method?
Year
0
1
2
3
FCFE ($ million)
_____
_____
_____
_____
Explanation / Answer
a)
FCFE = FCF - After tax Interest - Increase in Debt
FCFE0 = -100 + 40.1 - 0 = -59.9
FCFE1 = 52 + (32.1-40.1) - 2.73*(1-36%) = 42.25
FCFE2 = 95 + (14.15-32.1) - 2.19*(1-36%) = 75.65
FCFE3 = 70 + (0-14.15) - 0.96*(1-36%) = 55.24
b)
NPV =-59.9+ 42.25/(1+10.1%) + 75.65/(1+10.1%)2 + 55.24/(1+10.1%)3 = 82.27
WACC method
Firm value = 52/(1+8.84%) + 95/(1+8.84%)2 + 70/(1+8.84%)3 = 182.26
NPV = 182.26 - 100 = 82.26
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