Topics: Discounted cash flow, Free cash flow, Net present value Pages: 2 (524 words) Published: January 23, 2013
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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