Question
Joe Exotic Inc. is considering expanding into the cruise line business. To finance the expansion project, Joe Exotic will issue a 3-year, zero coupon bond
Joe Exotic Inc. is considering expanding into the cruise line business. To finance the expansion project, Joe Exotic will issue a 3-year, zero coupon bond with face value of $500 million for $450.97 million. Joes consultants have analyzed the cruise line market and produced the following scenarios for the expansion project for each of the next three years:
Probability | EBIT | Depreciation | CapEx | |
High | .35 | 750 | 50 | 50 |
Medium | .35 | 500 | 50 | 50 |
Low | 0 | 0 | 50 | 50 |
Joes consultants have determined that the unlevered cost of capital in the cruise line industry is 6%. The expected return on the market portfolio is 4.75% and the risk-free rate is 1.50%. Joe Exotic Inc. has a D/E ratio of 0.75 and is subject to a 35% corporate tax. (Note: When EBIT is less than debt interest, a firm is unable to get a tax deduction.)
a) Use the APV approach to evaluate Joes expansion project. Should Joe Exotic invest into the cruise line business if the initial cost is $800 million?
b) List three scenarios in which you would prefer to use the APV approach over the WACC approach.
Note: Show your work in detail
Step by Step Solution
There are 3 Steps involved in it
Step: 1
Get Instant Access to Expert-Tailored Solutions
See step-by-step solutions with expert insights and AI powered tools for academic success
Step: 2
Step: 3
Ace Your Homework with AI
Get the answers you need in no time with our AI-driven, step-by-step assistance
Get Started