Question
A project has an expected free cash flow of $100 million a year from now (no other cash flows afterwards). We have identified a comparison
A project has an expected free cash flow of $100 million a year from now (no other cash flows afterwards). We have identified a comparison firm with similar investments. The equity beta of the comparison firm is 1.4, and it has a D/E ratio 1. We plan to have a D/E ratio of 0.75 for the project. The risk-free rate is 5%, and the market risk premium is 10%. The tax rate is 30%. a) (12 points)Use the WACC method to calculate the value of the project. Assume that both the comparison firm and out firm have risk-free debt and risk-free tax shields.
b) (13 points)Now suppose the comparison firm has risk-free debt, but the projects debt is risky. Specifically, the beta of our bonds is 0.2, and the yield-to-maturity of the bond is 8%. The tax shields will be utilized fully 90% of the time. Assume that the debt and the tax shields are equally risky. Calculate the WACC in this scenario and find the value of the project.
Step by Step Solution
There are 3 Steps involved in it
Step: 1
Get Instant Access to Expert-Tailored Solutions
See step-by-step solutions with expert insights and AI powered tools for academic success
Step: 2
Step: 3
Ace Your Homework with AI
Get the answers you need in no time with our AI-driven, step-by-step assistance
Get Started