FINC 560 - Final Exam
FINC 560 - Final Exam
FINC 560 - Final Exam
1. (15pts) Your firm is considering expanding its household products division (100%
equity financed). You identify P&G as a firm with comparable investments.
Suppose P&Gs equity has an equity market capitalization of 150 billion and an
equity beta of 0.6. P&G also has $38 billion of AA rated debt outstanding
(assume that debt beta is zero), with an average yield of 3.5%. P&G has $2
billion of an excess amount of cash. Estimate the cost of capital of your
firms investment using the two different equations. A risk free rate of
3% and a market risk premium of 5% are given. (Use the net debt
concept)
Key Information:
rf: 3%
Beta: 0.6
rp: 5%
E D
Formula: 1) ri = rf + Beta x E [Rmkt] rf 2) ru= E+ D
+ rD
E+ D
1
rWACC = ((150/ (150+36) * 6%) + ((36) / (150+36)) * 3.5% =5.6%
(10pts) Estimate the cost of capital of the new investment (using the two
different equations for the cost of capital, which are traditional WACC
equation and project based WACC equation.
3. (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 Lucents cost of debt is 6% and its marginal tax rate is 35% (Note: Use
Net Debt concept (ND) and leverage ratio = ND/(ND+E)).
Key information
ru=9%
E=10 Billion
D=4 Billion
Tc=35%
rd = 6%
2
Excess cash = 0.4 billion, then, NET Debt = 4-0.4 = 3.60 Billion
#Question 3 (5pts): If Lucent maintains its leverage ratio, what is the debt
capacity of the project in the previous question? (use the Leverage ratio in
Question 3.1)
Year 0 1 2 3
FCF -120 60 100 80
VL 200.68 160.60
74.31 0
D = d*VL 52.18 41.76
19.32 0
3
o Pre-determined Interest tax shields: $2.3 million at t=1, $2.3 million at
t=2, $2.3 million at t=3, $2.7 million at t=4, $2.8 million at t=5
(assuming that cost of debt is 7% for the target firm and this rate is for
the PV of tax shield)
Estimation of FCF at t=6 is $11 million (after t=6 and beyond, FCF will grow
at the constant growth rate = 5% and cost of capital = 9%)
Question : Perform NPV analysis for this project using APV method. (You should
include discounted cash flows for five years as well as continuation value)
Adjusted present value of the project = Unlevered NPV of free cash flows for 5 years
+ NPV of assumed terminal (or continuation) value + NPV of pre-determined
interest tax shield for 5 years
FCFF Estimated = 13 million (t = 1), 7.4 million (t = 2), -5.8 million (t = 3), 1.4
million (t = 4), and 10.3 million (t = 5)
PV Calculation
PV = $172.17 million
4
NPV of interest tax shields for 5 years
Adjusted present value of the project is, therefore, -$124.48+ $172.17 + $10.09
= $57.78 million