Question
Advanced Technology Inc. has $600 of debt and $200 of equity (market values). It pays corporate taxes at the 40% rate. It faces the following
Advanced Technology Inc. has $600 of debt and $200 of equity (market values). It pays corporate taxes at the 40% rate. It faces the following investment opportunity:
- Expected cash flows (before tax) of $100 for 30 years, starting in year 1
- Initial investment = $150
- Industry cost of capital (return of assets) = 10%
- Project is to be financed entirely from external sources (by raising new debt or equity)
(a) The new project will be financed entirely with equity. Value the project using 1) WACC and 2) APV
(b) What is the value of the project if the firm decides to borrow $130 at 8% to finance it?
(c) What is the value of the project if the firm decides to maintain its existing debt-to-equity ratio?
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