Consider a project with the following pro-forma asset and income statements for year 0 and 1. (in Pro-forma income, inflows are shown as (+) values are outflows are shown as () values).

a. Determine the unlevered free cash flows of the project for year 0 and year 1. (Note: Capex in year 1 is change in Capital Assets + Depreciation)

Year	0	1
PRO FORMA ASSETS
Capital Assets	100	105
NWC	10	10.5
PRO FORMA INCOME
Cash Revenues		250
Cash Variable Costs		-200
Cash Fixed Costs		-20
Depreciation		-10
Taxable Income		20
Taxes (25%)		-5
After-tax Income		15

b The unlevered beta of the assets (U) for this project is 1.5. The current risk-free interest rate is 3.0% per year and the expected market risk premium (E(MRP)) = 6.0% per year. Determine the CAPM estimate of the unlevered cost of capital rU.

c. Assume the unlevered free cash flows of this project after year 1 continue on forever growing at a rate of 5% per year (a growing perpetuity assumption). Determine the unlevered NPV AND market value, VU, of this project. (Hint Market value = NPV + Investment at year 0 = PV(FCF year 1 and onward))

d. You are asked about the sensitivity of the models output to changes in certain assumptions. Determine whether a 10% increase in cash fixed costs or a 1% increase in the cost of capital has a larger impact on VU.

e. This project is planning on using some debt. The project plans to use debt to maintain a capital structure where the debt to value ratio (D/V) is targeted at 0.30 for the life of the project. At this level of leverage, the projects borrowing costs, rD, will be 4.0%, with a corresponding debt beta, D, of 0.17. The tax rate is 25%. Given the above information, determine an estimate of rWACC for this project.

f. Under the capital structure assumptions of part e, determine the levered value of this project, VL, , given this weighted average cost of capital.

g. Calculate the amount of debt that the project will need to take at year zero to produce the targeted capital structure, D/VL = 0.30 AND calculate the projects interest tax shield (ITS) for year 1. (tax rate = 25%)

h. Discuss the estimate of VL from the model in part (f) in terms of a being the true valuation for the project. What important possible cash flows (inward or outward) are missing from the models estimate of levered value?