Question
A).Cerro Corp. is valuing a new project that requires an initial investment of $100 million and will result in free cash flows of $10 million
A).Cerro Corp. is valuing a new project that requires an initial investment of $100 million and will result in free cash flows of $10 million next year. The free cash flows will increase by 3% every year in perpetuity. The project represents average risk for Cerro. Cerros debt to equity ratio is 1:2 and it will maintain this ratio in future. Cerros cost of equity is 15.6% and it cost of debt is 6%. The corporate tax rate is 20%. What is the value of the project to Cerro?
B).Suzhou Corp. has $600 million in equity, $200 million in debt, and no excess cash. Its cost of equity is 10% and cost of debt is 5%. The corporate tax rate is 20%. Suzhou is considering a new project that requires initial investment of $100 million and will result in free cash flows of $50 million after one year, $60 million after two years, and finally $30 million after three years. Assuming that the project has the same risk as Suzhous existing business and the firm wants to maintain its debt to equity ratio, calculate the debt capacity of Suzhous new project now, after one year, and after two years.
C). Minsk Manufacturing Corp. is valuing a new project. The project requires an initial investment of $30 million and will last ten years. The project will result in revenues of $10 million and costs of $5 million in each of these ten years. Ignore depreciation and net working capital requirements. Minsk will raise $10 million of debt to finance the project. It will repay $5 million of debt after three years from today and the rest five years from today. The cost of debt is 5%. The cost of capital of other all-equity firms with similar businesses is 10%. The corporate tax rate is 20%. What is the value of the project?
D).Shiraz Industries is considering borrowing $200 million to fund a new project. The market is uncertain about the projects risk so Shiraz will have to pay a 6% interest rate on this loan. The actual risk of the loan is low so that the appropriate loan rate given the risk of the project is 5%. The entire principal will be repaid after four years. The corporate tax rate is 20%. Determine the effect of the loan on the value of the project.
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