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Propel Corporation plans to make a $ 49.5 million​ investment, initially funded completely with debt. The free cash flows of the investment and​ Propel's incremental debt from the project are shown​ here:​

Year 0 1 2 3
Free Cash flows ($ million) -49.5 39.6 21.8 24.8
Debt ($ million) 49.5 31.6 13.9 0.0

Propel's incremental debt for the project will be paid off according to the predetermined schedule shown.​ Propel's debt cost of capital is 7.4 %, and its tax rate is 35 %. Propel also estimates an unlevered cost of capital for the project of 12.6 %.

a. Use the APV method to determine the levered value of the project at each date and its initial NPV.

b. Calculate the WACC for this project at each date. How does the WACC change over​ time? Why?

c. Compute the​ project's NPV using the WACC method.

d. Compute the equity cost of capital for this project at each date. How does the equity cost of capital change over​ time? Why?

e. Compute the​ project's equity value using the FTE method. How does the initial equity value compare with the NPV calculated in parts (a​) and ​(c​)?

Hint​: Make sure to round all intermediate calculations to at least four decimal places.

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Nestor Rutherford
Nestor RutherfordLv2
28 Sep 2019

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Felicia & Fred�s executive board has asked you to change the decision model previously completed to reflect the following changes regarding increased leverage, WACC, and cash flows. It is your job to calculate the decision rules for NPV and IRR given the information provided.

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Consider the following information on Huntington Power Co.

Debt: 4,000, 7% semiannual coupon bonds outstanding, $1,000 par value, 18 years to maturity, selling for 102 percent of par; the bonds make semiannual payments.

Preferred Stock: 10,000 outstanding with par value of $100 and a market value of 105 and $10 annual dividend.

Common Stock: 84,000 shares outstanding, selling for $56 per share, the beta is 2.08

The market risk premium is 5.5%, the risk free rate is 3.5% and Huntington’s tax rate is 32%.

Huntington Power Co. is evaluating two mutually exclusive project that is somewhat riskier than the usual project the firm undertakes; management uses the subjective approach and decided to apply an adjustment factor of +2.1% to the cost of capital for both projects.

Project A is a five-year project that requires an initial fixed asset investment of $2.4 million. The fixed asset falls into the five-year MACRS class. The project is estimated to generate $2,050,000 in annual sales, with costs of $950,000. The project requires an initial investment in net working capital of $285,000 and the fixed asset will have a market value of $225,000 at the end of five years when the project is terminated.

Project B requires an initial fixed asset investment of $1.0 million. The marketing department predicts that sales related to the project will be $920,000 per year for the next five years, after which the market will cease to exist. The machine will be depreciated down to zero over four-year using the straight-line method (depreciable life 4 years while economic life 5 years). Cost of goods sold and operating expenses related to the project are predicted to be 25 percent of sales. The project will also require an addition to net working capital of $150,000 immediately. The asset is expected to have a market value of $120,000 at the end of five years when the project is terminated.

Use the following rates for 5-year MACRS: 20%, 32%, 19.2%, 11.52%, 11.52%, 5.76%

Calculate WACC for the firm

What is the appropriate discount rate for project A and project B?

Calculate project A’s cash flows for years 0-5

Calculate project B’s cash flows for year 0-5

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Calculate NPV, IRR and PI for project B

Which project should be accepted if any and why?

What is the NPV profile’s crossover rate (incremental IRR)?

By just considering the crossover rate, and without recalculating NPV or IRR, which project would you select if the appropriate discount rate for both projects is 8% and why?

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Debt: 4,000, 7% semiannual coupon bonds outstanding, $1,000 par value, 18 years to maturity, selling for 102 percent of par; the bonds make semiannual payments.

Preferred Stock: 10,000 outstanding with par value of $100 and a market value of 105 and $10 annual dividend.

Common Stock: 84,000 shares outstanding, selling for $56 per share, the beta is 2.08

The market risk premium is 5.5%, the risk free rate is 3.5% and Huntington’s tax rate is 32%.

Huntington Power Co. is evaluating two mutually exclusive project that is somewhat riskier than the usual project the firm undertakes; management uses the subjective approach and decided to apply an adjustment factor of +2.1% to the cost of capital for both projects.

Project A is a five-year project that requires an initial fixed asset investment of $2.4 million. The fixed asset falls into the five-year MACRS class. The project is estimated to generate $2,050,000 in annual sales, with costs of $950,000. The project requires an initial investment in net working capital of $285,000 and the fixed asset will have a market value of $225,000 at the end of five years when the project is terminated.

Project B requires an initial fixed asset investment of $1.0 million. The marketing department predicts that sales related to the project will be $920,000 per year for the next five years, after which the market will cease to exist. The machine will be depreciated down to zero over four-year using the straight-line method (depreciable life 4 years while economic life 5 years). Cost of goods sold and operating expenses related to the project are predicted to be 25 percent of sales. The project will also require an addition to net working capital of $150,000 immediately. The asset is expected to have a market value of $120,000 at the end of five years when the project is terminated.

Use the following rates for 5-year MACRS: 20%, 32%, 19.2%, 11.52%, 11.52%, 5.76%

Calculate WACC for the firm

What is the appropriate discount rate for project A and project B?

Calculate project A’s cash flows for years 0-5

Calculate project B’s cash flows for year 0-5

Calculate NPV, IRR and PI for project A

Calculate NPV, IRR and PI for project B

Which project should be accepted if any and why?

What is the NPV profile’s crossover rate (incremental IRR)?

By just considering the crossover rate, and without recalculating NPV or IRR, which project would you select if the appropriate discount rate for both projects is 8% and why?

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