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1. If the firm was entirely financed, we can consider its competitors, and, as comparables. Through the CAPM formula, we can calculate appropriate discount rate as follows. rU=5.0%+1.50*7.2%=15.8%

The annual projected free cash flows which are presented in the Exhibit 1 are $-112,000; $6,000; $151,000; $314,000; $495,000 respectively for year from 2002 to 2006. After year 2006, the free cash flow would grow at 5%, so we can calculate the terminal value of the project at the end of 2006 using the perpetual-growth DCF formula. TV2006=FCF2007k-g=FCF2006*1.05k-g=5197500.108=$4,812,500

The value of the project is:

2. If the firm raises $750,000 of debt to fund the project and keeps the level of debt constant in perpetuity, we can consider the interest tax shields as a perpetuity. annual interest tax shield=750000*6.8%*40%=$20,400

In this case, we assume the risk of the interest tax shield equals the risk of the debt. rTS=rD=6.8%
PVTax Shield=204006.8%=$300,000

3. We has known that rU=15.8%, rD=6.8%,DV=25%,EV=75%, through the formula rU=rDDV+rEEV , we can get: rE=18.8% WACC=rDDV1-Tc+rEEV=6.8%*25%*1-40%+18.8%*75%=15.12%
The terminal value of project at the end of 2006:
TV2006=FCF2007WACC-g=FCF2006*1.05WACC-g=5197500.1012=$5,135,870 Vproject=-1500000+-1120001.1512+60001.15122+1510001.15123+3140001.15124+4950001.15125+51358701.15125=$1,469,972

4. Firstly, we should calculate the present value of future free cash flows of each year. PVFuture FCF@2002=-1120001.1512+60001.15122+1510001.15123+3140001.15124+4950001.15125+51358701.15125=$2,969,972 The end-of-year debt balances, as presented in Exhibit 2, are at 25% constant rate of that year's project value.

5. The value of $1,528,485 from the APV approach is greater than the value of $1,469,972 from the WACC approach. The assumption of...
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