Problem 3.

After the recent food poisoning outbreak, Bullrito is considering a new marketing project to improve its brand image. At time 0, this project requires an operating expense of $40M to make a TV commercial. Bullrito plans to air this commercial over the next to years. Thanks to this new commercial, you expect that the firms EBIT will increase by $50.40M in year 1 and by $52.92M by year 2 . You wan to find the NPV of this project using two different methods.

• Bullritos D/E ratio is 2 and the firm plans to keep this ratio fixed
• Bullritos cost of debt is 3%. Under the current capital structure, the firms cost of equity is 15%
• Bullritos corporate tax rate is 30%

PART 0: Free Cash Flows

1. The project does not incur any incremental depreciation, CAPEX, nor net working capital requirements. The EBIT is summarized as the following. Find the free cash flow for each year.

Year 1Year 2Year 3EBIT-$40M$50.40M$52.92MFree Cash flow?????????

PART 1: WACC Method

For part 1, we assume that the new project is a carbon copy of the firms existing business.

1. What is Bullritos WACC?
2. What is the NPV of the project based on the WACC method?

PART 2: APV Method

1. What is bullritos unlevered cost of capital?
2. What is the discount rate for future interest tax shields (i.e. r its) explain your answer
3. Find the interest expense and interest tax shield each year if the amount of debt for the project is given as the following:

Year 0Year 1Year 3Debt amount$43.92M$23.21M$0MInterest expense?????????Interest tax shield?????????

1. What is the present value of the interest tax shield (Vits)?
2. What is the NPV of the project if it were financed by 100% equity (i.e. unlevered: NPVu)
3. Finally, what is the NPV of the project based on the APV method?