Question: For this assignment you are required to complete calculations covering the concepts that were examined this week:
1. Firm J, which is in the 40% tax rate, is considering a project that would result in gross cash flows of £5,000,000 with annual costs and expenses of £1,000,000. The project will cost £12,000,000 and is expected to continue into perpetuity. If the unlevered cost of equity for Firm J is 20%, what is the net present value (NPV) of the project, and what decision should the firm make regarding its acceptance?
Firm J is considering financing 25% of the project with debt, which can be obtained at a rate of 10%. Determine the value of the project under levered conditions using the adjusted present value (APV), flow to equity (FTE), and weighted average cost of capital (WACC) methods. How does this change the decision compared to unlevered conditions?
2. Two firms, similar in size and operations, are considering undertaking the same investment. The investment would cost £2,000,000 and the estimated cash flows are £800,000 per year into perpetuity. Costs and expenses associated with the project are estimated to be £200,000 each year into perpetuity as well. Firm A, a publicly traded firm, is currently unlevered and plans to finance the project with equity, which is a rate of 20%. Firm B, a private firm, will finance the project with a debt-to-value ratio of 0.5 (a debt-to-equity ratio of 1:1). Firm A has an unlevered beta of 1.2, which is the average for companies within their industry. Assuming a risk-free rate of 4.5%, a market risk premium of 5.5%, and a corporate tax rate of 35%, what is the levered beta of Firm B, and what is the NPV of the project for each firm? What inferences can you make with this information?
Use the Turnitin link below to submit your written analysis (*.doc or *.docx) and the Assignment link to submit your spreadsheet with your calculations used in support of your analysis (*.xls or *xlsx). Please cite the article and the book chapter in Harvard citation in the assignment.
References: 1. Journal of Applied Corporate Finance SPRING 1 997 VOLUME 1 0 . 1
Two DCF Approaches for Valuing Companies Under Alternative Financing Strategies (And How to Choose Between Them) by Isik Inselbag and Howard Kaufold
2. Valuation and Capital Budgeting for the Levered Firm