6. 7points) Soleil Inc. makes circus equipment. The firm currently has a debt-eq

Question

6. 7points) Soleil Inc. makes circus equipment. The firm currently has a debt-equity ratio of 0% and is in the 35% tax bracket. The required return on the firm's levered equity is 18%. Soleil is planning to expand its production capacity. The equipment to be purchased is expected to generate the following unlevered cash flows: Year Cash Flow S16M low-S20M S9M The company has arranged an S8M debt issue to partially finance the expansion. The loan has an interest rate of9% at the company's regular pretax cost ofdebt. The company pay the debt in two equal installments. Using the APV method, should Soleil proceed with would the expansion?

Explanation / Answer

Tax Rate 35.0% Terminal Growth Rate 0.0% CAPM Discount Rate 18.0% Year 0 Year 1 Year 2 Discount Factor 1.00 0.85 0.72 Free Cash Flow EBIT       9.00      16.00 Less: Taxes           -        -3.15      -5.60 EBIAT           -         5.85      10.40 Less: Capex     -20.00           -             -   FCF     -20.00       5.85      10.40 PV of FCF     -20.00       4.96       7.47 Sum of PV of FCF + TV      -7.57 Interest Tax Shields Interest Expense           -         0.72       0.36 Total ITS Used           -         0.25       0.13 ITS Used           -         0.25       0.13 PV of ITS Used           -         0.21       0.09 Sum of PV of ITS Used       0.30 Adjusted Present Value      -7.27 No, Soleil should not process with the expansion

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