'_.___._.. . . uuuLuI LIV) FunnI {14% Considering the information for the following two firms, which of the rms would undertake a project with expected retum equal to 8.5% if the only option LE: available is all equity nancing? Firm Cash Debt Equity r9 r5 1'; mg Eenie U 150 150 5% 10% 40% Mee n i e U 250 T50 5% 12% 35% Answers: a. Eenie since it has a higher unlevered cost of capital than Meenie b. Meenie since it has a higher unlevered cost of capital than Eenie c. Eenie since the project has positive NPV onlyI for this rm cl. None of the rms would consider investing in it because it has negative NP\.4r for both Response Given that on l1; all equity nancing is available, we have to focus on the unlevered cost of capital to determine whether the project has Feedback: positive NPV. how to calculate it Firm Cash Debt Equity r5 :1: r runfevered Eenie U 150 150 5% 10% 40% 8.125% Meenie 0 250 750 6% 12% 35% Therefore, onlyr Eenie will invest in that project ('78 The Aardvark Corporation is considering launching a new product and is trying to determine an appropriate discount rate for evaluating this nev.r product. La Aardvark has identied the following information for three single division lms that offer products similar to the one Aardvark is interested in launching. Based upon the three comparable rms. what is the most appropriate unlevered cost of capital torAardvark to use on this new product? Equity Cost of Debt Cost of E: Comparable Firm Capital Capital Debt-to-Value Ratio Anteater Enterprises 12.50% 5.50% 50% Armadillo Industries 13% 5.10% 40% Antelope Inc. 14% 1".1 0% 60% Al'lSWEl'S: a. 12.50% b_1o.24% [I 9.8?% d_11.21% Response Feedback: This is a case of comparable firms, so taking a simple average is enough. Equity Cost of Debt Cost of DebttoValu Comparable Firm Capital Capital Ratio Anteater Enterprises 12.50% 6.50% 50% 9.50% Armadillo Industries 13 % 6.10% 40% 10.24 % Antelope Inc. 14 % 7.10% 60% 9.36 % average 9.37 % Question 15 Grant of2.6? points If ' Suppose that Rose Industries is considering the acquisition of another lm in its industry for $100 million. The acquisition is expected to increase Rose's Cd free cash flow by $5 million the rst year, and this contribution is expected to grow at a rate of 3% every year there alter. Rose currently maintains a debt to equity ratio of 1, its marginal tax rate is 40%, its cost of debt m is 6% and its cost of equity rg is 10%. Rose Industries will maintain a constant debtequity ratio for the acquisition. Given that Rose issues new debt of $50 million initially to fund the acquisition, the present value of the interest tax shield for this acquisition is closest to: Answer; a. 15 million why the cost of debt is 6%, but in the eqUatign b. 20 million below It s 7% c. 24 million d. 31.58 million Response Feedback: _ E D runlevered_ E+DrE + E+DFD l runlevored= 1(010)+l+l @ 0.08 51 U== V 0.03-0.03 100 E o mw' 2+0r5 +1E+D ammo-1+1") 10) +c0 073(1 0. 40)- -o .068 _,_.: rD(l T) 5 L V [LOSS0.03 131.58 vL =v" +PVCtax shield) Pvtax shield) =VL Vu=13 1.58 100=31.58 million