Consider a firm as follows: The cashflows are received at the end of each year and are perpetual. Cost of equity capital for an unlevered firm, r₀ , is 20%. The first cash-flow will be received one year from today. All calculations for valuation are done today. Firm value is defined as collective value of debt and equity.

Sales $ 500,000

Cash Costs 360,000

________

Operating Income 140,000

Tax @ 34% -47,600

________

Unlevered cash flow (UCF) $ 92,400

1. Assume that the firm has no debt. Find the firm value, using:

a) APV method $__________.

b) FTE method $__________.

c) WACC method $__________.

2. Now assume that the firm has $126,229.50 of debt. Interest rate on debt is 10%. Find the firm value using:

d) APV method $__________.

e) FTE method $__________.

f) WACC method $__________.

Objective: To illustrate that financing has no impact on firm value if there are no taxes (i.e. financing affects firm value purely because the interest payments generate tax-savings), and to further illustrate the equivalence of various valuation methods.

3. Assume the the firm has $ 100,000 of debt @ 10% and the tax rate is zero. Find the firm value using:

g) APV method $__________.

h) FTE method $__________.

i) WACC method $__________.

4. Assume the the firm has $ 200,000 of debt @10% and the tax rate is zero. Find the firm value using:

j) APV method $__________.

k) FTE method $__________.

l) WACC method $__________.