Question
5. Your firm is considering a $150 million investment to launch a new product line. The project is expected to generate a free cash flow
5. Your firm is considering a $150 million investment to launch a new product line. The project is expected to generate a free cash flow of $20 million per year, and its unlevered cost of capital is 10%. To fund the investment, your firm will take on $100 million in permanent debt.
a. Suppose the marginal corporate tax rate is 35%. Ignoring issuance costs, what is the NPV of the investment?
b. Suppose your firm will pay a 2% underwriting fee when issuing the debt. It will raise the remaining $50 million by issuing equity. In addition to the 5% underwriting fee for the equity issue, you believe that your firms current share price of $40 is $5 per share less than its true value. What is the NPV of the investment? (Assume all fees are on an after-tax basis.)
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