You are a consultant who has been hired to evaluate a new product line for Marku
ID: 2800571 • Letter: Y
Question
You are a consultant who has been hired to evaluate a new product line for Markum Enterprises. The upfront investment required to launch the product line is $11 million. The product will generate free cash flow of $0.77 million the first year, and this free cash flow is expected to grow at a rate of 6% per year. Markum has an equity cost of capital of 11.7%, a debt cost of capital of 5.73%, and a tax rate of 42%. Markum maintains a debt-equity ratio of 0.70.
a. What is the NPV of the new product line (including any tax shields from leverage)?
b. How much debt will Markum initially take on as a result of launching this product line?
c. How much of the product line's value is attributable to the present value of interest tax shields?
Explanation / Answer
a. What is the NPV of the new product line (including any tax shields from leverage)?
b. How much debt will Markum initially take on as a result of launching this product line
How much of the product line's value is attributable to the present value of interest tax shields?
Before Tax shield NPV = -$9,577,436.45
After Tax sheild NPV = -$9,543,047.6
Interest Tax sheild contributation =$34,388.79
Product Line $11 Million Free Cashflow $0.77 million Free cash flow expected to grow 6% Equity cost 11.70% Tax rate 42% Debt cost of capital 5.73% Include Tax Sheild Debt cost*(1-Tax) 0.033234 Debt Cost Of capital 3.32% Dbt equity ratio 0.7 Cost of capital WACC Equity cost*(weightage)+ Debt Cost*(weightage) =11.70%(0.30)+3.32%(0.70) 0.05834 5.8% NPV For new product ine Cashflow for first Year $770,000 Cash Flow for second year (Growth At 6%) $816,200 -intial Investment+C1/(1+r)+ C2/(1+r)^2……….C3/(1+r)^n - 11million+0.77million/(1+0.058)+0.82/(1+0.058)^2 NPV For new product ine -$9,543,047.66Related Questions
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