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You have been recently hired as a financial analyst. When you arrive at work on Monday morning, the CFO of the firm sends you a
You have been recently hired as a financial analyst. When you arrive at work on Monday morning, the CFO of the firm sends you a message asking you to step into her office as soon as you have a
free minute. Having been on the job just two weeks, you quickly decide you have a free minute and go to the executive floor, where the CFO has her office. You discover that the CFO wants you to
educate her on the meaning and use of the APV valuation method. Although she does not elaborate on the reason for her request, you are aware of the office scuttlebutt that the board of directors is
considering the prospect of taking the firm private and is in discussions with an investment banker about the particulars of the deal.
After leaving the CFO's office, you decide that the best way to explain the use of the APV methodology is to construct a simple example. After thinking about it for an hour or so, you come up with
the following illustration:
Catch-Me Lures, Inc. is a very stable business with expected FFs of $2,000 per year, which is likely to be constant for the foreseeable future. The firm currently has no debt outstanding and has an
equity beta of 1.0. Given a market risk premium of 5% and a risk-free rate of interest of 3%, you estimate the unlevered cost of equity for the firm to be 8%. Assume the firm borrows $5000.00 at a
rate of 4% and the firm pays a tax rate of 20% What is the value of the levered firm (i.e., the APV valuation)? Round answer to the nearest dollar.
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