Your firm is considering a new three-year project. You know that the

unlevered cost of equity for firms with a similar risk as your target is 8%. At the end of the

project, all available funds are distributed to equity and debt holders. Use the following

financial statements to answer the questions on the next page:

Year	0	1	2	3
Income statement
Sales		$175,000	$175,000	$175,000
COGS		$26,250	$26,250	$26,250
Depreciation		$100,000	$100,000	$100,000
EBIT		$48,750	$48,750	$48,750
Interest payment on debt		$9,000	$9,000	$9,000
Profit Before tax		$39,750	$39,750	$39,750
Taxes		$21,863	$21,863	$21,863
Profit after tax		$17,888	$17,888	$17,888
Dividends		$17,888	$17,888	$17,888
Retained earnings		$0	$0	$0

Balance Sheet
Cash and Mark. Sec.	$0	$100,000	$200,000	$300,000
Current Assets	$0	$0	$0	$0
Fixed Assets
At cost	$300,000	$300,000	$300,000	$300,000
Acc. Depreciation	$0	$100,000	$200,000	$300,000
Net Fixed Assets	$300,000	$200,000	$100,000	$0
Total Assets	$300,000	$300,000	$300,000	$300,000
Current liabilities	$0	$0	$0	$0
Debt	$150,000	$150,000	$150,000	$150,000
Stock	$150,000	$150,000	$150,000	$150,000
Acc. Ret. Earn.	$0	$0	$0	$0
Total liab.and equity	$300,000	$300,000	$300,000	$300,000

a) How large an equity investment does the project require upfront?

b) How much equity is recovered at the end of the project?

c) Show the cash to and from equity holders for the entire project. Don’t forget

about dividends, initial, and terminal equity flows. Actual cash, not free cash flow!

Year	0	1	2	3
Total cash flows to equity

d) Based on the cash flows in part c, what is the IRR for the equity holders?

e) What is the present value of the tax shield for this three-year project?

Remember, this is not a perpetuity, it’s a three-year project.

f) Is this a good project for shareholders?