Individual Project

FIN 251 Fall 2020

Due date: Nov 18^thWednesday

Assuming that there is an unlevered firm and a levered firm. The basic information is given by the following table.

Table1: Information of the firms

Unlevered firm

Levered firm

EBIT

10000

10000

Interest

0

3200

Taxable income

Tax (tax rate: 34%)

Net income

CFFA

Assuming that cost of debt =8%; unlevered cost of capital =10%; systematic risk of the asset is 1.5

1)Fill in the blanks

2)What is the present value of the tax shield?

(.34)*(3,200)=1,088

3)What is the size of debt?

(.08)*(x)=3,200x=40,000

4)Calculate the following values:

a) value of unlevered firm; b) value of the levered firm; c) equity value; d) Cost of equity; e) cost of capital; f) systematic risk of the equity

5)Suppose that the firm changes its capital structure so that the debt-to-equity ratio is 1.0, then recalculate the systematic risk of the equity

6)Based on the results of question (4), if there are the following two mutually exclusive projects. What is the crossover required rate of return for the two projects?

7)Based on the previous discussions, are you going to accept project A or B? Why?