EBK CORPORATE FINANCE
4th Edition
ISBN: 8220103145947
Author: DeMarzo
Publisher: PEARSON
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Textbook Question
Chapter 18, Problem 18P
You are on your way to an important budget meeting. In the elevator, you review the project valuation analysis you had your summer associate prepare for one of the projects to be discussed:
Looking over the spreadsheet, you realize that while all of the cash flow estimates are correct, your associate used the flow-to-equity valuation method and discounted the cash flows using the company’s equity cost of capital of 11%. While the project's risk is similar to the firm’s, the project’s incremental leverage is very different from the company's historical debt-equity ratio of 0.20: For this project, the company will instead borrow $80 million upfront and repay $20 million in year 2, $20 million in year 3, and $40 million in year 4. Thus, the project's equity cost of capital is likely to be higher than the firm’s, not constant over time-invalidating your associate’s calculation.
Clearly, the FTE approach is not the best way to analyze this project. Fortunately, you have your calculator with you, and with any luck you can use a better method before the meeting starts.
- a. What is the
present value of the interest tax shield associated with this project? - b. What are the
free cash flows of the project? - c. What is the best estimate of the project’s value from the information given?
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You are a project manager for your company and you are faced with five potential projects that you can invest in. Free cash flow projections and additional relevant data are
given for each project in the table below. Assume that there are no cash flows after year 3. Assume that you can only take each project once and that you can only choose one
project. Which project would you invest in? Select the best answer.
Project
Project A
Project B
Project C
Project D
Project E
O I. Project A
II. Project B
III. Project C
IV. Project D
O V. Project E
FCF Forecasts by Year (in $1,000)
0
2
1
500
(400)
(400)
(300)
(250)
(300)
75
60
75
135
115
175
3
650
210
190
200
Interest Rate (EAR)
8.0%
10.0%
10.0%
12.0%
12.0%
IRR
25.00%
17.57%
15.92%
17.81%
19.96%
As a recent graduate of the UWIOC, The General Manager of the company has hired you to work alongside the Financial Controller of the company to help determine whether the company should invest in the new product line. He has provided you with the following questions to guide you in your assessment of the project and to present your findings to the Company.
1. Determine the weighted average cost of capital (WACC) for Vigour Pharmaceuticals. (Formula to be used below)
For this assignment, you will apply what you have learned from the unit lesson and required unit resources. The Waterways (WP27) case is located on page 27-35 of the textbook.
Waterways puts much emphasis on cash flow when it plans for capital investments. The company chose its discount rate of 8% based on the rate of return that it must pay its owners and creditors. Using that rate, Waterways then uses different methods to determine the best decisions for making capital outlays.
This year, Waterways is considering buying five new backhoes to replace the backhoes it now has. The new backhoes are faster, cost less to run, provide for more accurate trench digging, have comfort features for the operators, and have 1-year maintenance agreements to go with them. The old backhoes are working just fine, but they do require considerable maintenance. The backhoe operators are very familiar with the old backhoes and would need to learn some new skills to use the new backhoes.
The following…
Chapter 18 Solutions
EBK CORPORATE FINANCE
Ch. 18.1 - What are the three methods we can use to include...Ch. 18.1 - Prob. 2CCCh. 18.2 - Prob. 1CCCh. 18.2 - Prob. 2CCCh. 18.3 - Prob. 1CCCh. 18.3 - Prob. 2CCCh. 18.4 - Prob. 1CCCh. 18.4 - Prob. 2CCCh. 18.5 - How do we estimate a projects unlevered cost of...Ch. 18.5 - What is the incremental debt associated with a...
Ch. 18.6 - Prob. 1CCCh. 18.6 - Prob. 2CCCh. 18.7 - How do we deal with issuance costs and security...Ch. 18.7 - Prob. 2CCCh. 18.8 - When a firm has pre-determined tax shields, how do...Ch. 18.8 - Prob. 2CCCh. 18 - Prob. 1PCh. 18 - Prob. 2PCh. 18 - In 2015, Intel Corporation had a market...Ch. 18 - Prob. 4PCh. 18 - Suppose Goodyear Tire and Rubber Company is...Ch. 18 - Suppose Alcatel-Lucent has an equity cost of...Ch. 18 - Acort Industries has 10 million shares outstanding...Ch. 18 - Prob. 8PCh. 18 - Prob. 9PCh. 18 - Consider Alcatel-Lucents project in Problem 6. a....Ch. 18 - Consider Alcatel-Lucents project in Problem 6. a....Ch. 18 - In year 1, AMC will earn 2000 before interest and...Ch. 18 - Prokter and Gramble (PKGR) has historically...Ch. 18 - Amarindo, Inc. (AMR), is a newly public firm with...Ch. 18 - Remex (RMX) currently has no debt in its capital...Ch. 18 - You are evaluating a project that requires an...Ch. 18 - Prob. 17PCh. 18 - You are on your way to an important budget...Ch. 18 - Your firm is considering building a 600 million...Ch. 18 - Prob. 20PCh. 18 - DFS Corporation is currently an all-equity firm,...Ch. 18 - Prob. 22PCh. 18 - Prob. 23PCh. 18 - Prob. 24PCh. 18 - XL Sports is expected to generate free cash flows...Ch. 18 - Propel Corporation plans to make a 50 million...Ch. 18 - Gartner Systems has no debt and an equity cost of...Ch. 18 - Revtek, Inc., has an equity cost of capital of 12%...
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