A large electronics company is considering making a $100M investment in a new product line. Assume that it will finance 60% of this investment with off-balance sheet financing at a debt cost of 5% (beta of debt is 0.3). The project is expected to generate project free cash flows of $10M each year (assume into perpetuity) and an unlevered beta of comparable firms/projects is 1.2. The firm is subject to a 35% corporate tax rate and you can assume the risk-free rate and market risk premium are 4% and 5%, respectively. Find the market value of the equity in the project and the project-specific WACC.

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Nestor RutherfordLv2

25 Jul 2019

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Assume that a company is expected to produce EBITDA of $90M in perpetuity. The corporate tax rate the company is subject to is 35%. To maintain the existing production capacities, capital expenditures are expected to be at $10M per year, in perpetuity. Annual depreciation, expected in perpetuity as well, is $10M. The current risk-free rate is 3%, and it is expected to remain so in perpetuity. The company has $200M in long-term debt, which is considered by the bank to be risk-free, so the interest rate the firm pays on its debt is 3%. The company expects to hold that amount of debt in perpetuity. Using stock returns on a comparable company that operates in the same industry, and has debt outstanding equal to 40% of the market value of its total capital, analysts estimated that the comparable companyâs beta is 1.8. The analysts believe the companies are comparable in all respects except for the capital structure, and do not expect that beta to change over time. You also know that the estimate of the market risk premium for the foreseeable future is 5%. Assume that the probability of financial distress for the firm is negligible, so that you can disregard it.

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The Value of an unlevered firm is 627.5 and levered 427.5 and WACC is 14.503% which were questions before this but with the same numbers.

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__________________