Question
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
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
- 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 1 | Year 2 | Year 3 |
EBIT | -$40M | $50.40M | $52.92M |
Free Cash flow | ??? | ??? | ??? |
PART 1: WACC Method
For part 1, we assume that the new project is a carbon copy of the firms existing business.
- What is Bullritos WACC?
- What is the NPV of the project based on the WACC method?
PART 2: APV Method
- What is bullritos unlevered cost of capital?
- What is the discount rate for future interest tax shields (i.e. r its) explain your answer
- Find the interest expense and interest tax shield each year if the amount of debt for the project is given as the following:
| Year 0 | Year 1 | Year 3 |
Debt amount | $43.92M | $23.21M | $0M |
Interest expense | ??? | ??? | ??? |
Interest tax shield | ??? | ??? | ??? |
- What is the present value of the interest tax shield (Vits)?
- What is the NPV of the project if it were financed by 100% equity (i.e. unlevered: NPVu)
- Finally, what is the NPV of the project based on the APV method?
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