8 5, (20 pts) Suppose Lucent has cost of equity of 9%, equity market capitalizat

Question

8 5, (20 pts) Suppose Lucent has cost of equity of 9%, equity market capitalization of $10 billion, and total debt 4 billion and 0.4 billion of excess amount of cash. Suppose Lucent's cost of debt is 6% and its marginal tax rate is 35% (Note: Use Net Debt concept (ND) and leverage ratio·D/(DE). #Question 1 (5pts), what is Lucent's WACC (after tax)? #Question 2 (5pts): if Lucent maintains a constant leverage ratio, what is the value of a project (levered value) with average risk based on the following expected free cash flows (Smillions) at each year? And perform NPV analysis. Note: WACC method (after-tax) Free Cash Flows:-120 (t-0), 60 (t=1), 100 (t-2), 80 (t-3) #Question 3 (5pts): If Lucent maintains its leverage ratio, what is the debt capacity of the project at each year? #Question 4 (5pts): Perform NPV analysis using APV method.

Explanation / Answer

1) WACC = wd x kd x (1 - tax) + we x ke

where, wd - weight of debt = ND / (ND + E) = (4 - 0.4) / (4 - 0.4 + 10) = 26.47%, kd - cost of debt = 6%, tax = 35%, we - weight of equity = E / (ND + E) = 1 - wd = 73.53%, kd - cost of equity = 9%

=> WACC = 26.47% x 6% x (1 - 35%) + 73.53% x 9% = 7.65%

2) NPV = FCF0 + FCF1 / (1 + wacc) + FCF2 / (1 + wacc)^2

= -120 + 60 / 1.0765 + 80 / 1.0765^2

= $4.77 million

3) Debt Capacity = PV of FCF x debt ratio (wd)

Year FCF PV Debt Capacity 0 -120 $124.77 $33.03 1 60 $74.31 $19.67 2 80 $0.00 $0.00

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