Valuation

a) Thunder Tech has $900,000 of debt on its balance sheet and pays corporate taxes at the 40% rate. The CEO of Thunder Tech faces an investment opportunity that requires an initial investment of $50,000 in new machinery and is expected to generate annual cash flows (before tax) of $30,000 for two years, starting in the first year. At the end of the second year, Thunder will be able to recover a salvage value of $8,000 by selling the projects machinery. Moreover, Thunder will be able to recover $2,000 of its inventory at the end of the second year (change in net working capital). The unlevered cost of capital is 10%.

What is the value of the project if Thunder Tech decides to issue $40,000 in bonds at an interest rate of 8% to finance the project? (3 marks)

b) OU Tech is planning to go public and sell 250,000 shares. OU Techs forecasted EBITDA for next year is $500,000. OU Tech has $100,000 debt in the form of bank loans. Kansas Tech, a public company that is similar to OU Tech in terms of its productive assets, has 1,000,000 shares outstanding. Kansas Techs shares are traded at $5 per share. Kansas has $400,000 debt on its balance sheet and analysts estimated its next years EBITDA to be $2,000,000. As the underwriter hired to assist OU Tech in its IPO, what price per share would you suggest OU Tech to sell its shares at? (3 marks)

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