Tybo Corporation adjusts its debt so that its interest expenses are 20% of its free cash flow.

Question:

Tybo adjusts its debt so that its interest expenses are 20% of its free cash flow. Tybo is considering an expansion that will generate free cash flows of $2.5 million this year and is expected to grow at a rate of 4% per year from then on. Suppose Tybo’s marginal corporate tax rate is 40%.
a. If the unlevered for this expansion is 10%, what is its unlevered value?
b. What is the levered value of the expansion?
c. If Tybo pays 5% interest on its debt, what amount of debt will it take on initially for the expansion?
d. What is the debt-to-value ratio for this expansion? What is its WACC?
e. What is the levered value of the expansion using the WACC method?

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