a) Suppose XYZ Enterprises has an equity cost of capital of 12%, market capitalization of $ 12 billion, and an enterprise value of $ 16 billion. Suppose XYZs debt cost of capital is 7.2% and its marginal tax rate is 35%.

i. What is XYZs WACC?

ii. If XYZ maintains a constant debt-equity ratio, what is the value of a project with average risk and the following expected free cash flows (in $ millions)?

Year 0,1,2,3

FCF -120,60,110,65

iii. If XYZ maintains its debt equity ratio, what is the debt capacity of the project in part (ii) above?

iv. What is XYZs unlevered cost of capital? v. What is the unlevered value of the project? vi. What are the interest tax shields from the project? What are their present values?

vii. Show that the APV of XYZs project matches the value computed using the WACC method. (25 marks)