Company TC is considering a project that has a cost of capital of 12% if it is financed entirely with equity. The project is expected to generate unlevered pre-tax cash flows in the next three years and all the years after year three as follows (the corporate tax rate is 35%): Cash flows (in $ millions) at End of Year 1 Year 2 Year 3 Years 4 5 and all future years

$100 $100 $500 $600 (growing at 5% each year)

Initially, the project will be financed with equity only (You can use the full equity project rate to discount any future cash flows, including any future tax shield value, for the first three years). At the start of year 4, it will repurchase some of its equity and borrow to the the debt value which is 50% of the unlevered project value at the time (at the beginning of year 4). And the debt level will be maintained for all the years afterwards. The borrowing rate at the time is expected to be 8.2% per year and the corporate tax rate is 35%. We are interested to know the present value of the project (considering the tax shield effect involved with the debt finance and only corporate tax is considered here).

a) What is the projects unlevered present value (at the beginning of year 1), assuming no debt will be used in all of the future years? b) Calculate the value of debt to be issued at the beginning of year 4.

c) Calculate the present value of the project under the debt finance plan (including the tax shield effect).