a. Suppose that Firms U and L are growing at a constant rate of 7% and that the investment in net operating assets required to support this growth is $50,000 (10% of EBIT). Use the compressed APV model to estimate the value of U and L, estimate the levered cost of equity, and find the WACC.
b. Now suppose the expected FCF for Y1 is $250,000 but it is expected to grow unevenly over the next 3 years: FCF Y2 = $290,000 and FCF Y3 = $320,000, after which it will grow at a constant rate of 7%. The expected interest expense at Y1 is $80,000, but it is expected to grow over the next couple of years before the capital structure becomes constant: Interest expense at Y2 will be $95,000, at Y3 it will be $120,000 and it will grow at 7% thereafter. What is the estimated horizon unlevered value of operations (i.e. the value at Y3 immediately after the FCF at Y3)? What is the current unlevered value of operations? What is the horizon value of the tax shield at Y3? What is the current value of the tax shield? What is the current total value? The tax rate and unlevered cost of equity remain at 40% and 14%, respectively.