19.

3
Calculate the weighted-average cost of capital (WACC) for Federated Junkyards of America, using the following information:
Debt: $75,000,000 book value outstanding. The debt is trading at 90% of book value. The yield to maturity is 9%
Equity: 2,500,000 shares selling at $42 per share. Assume the expected rate of return on Federated’s stock is 18%. ∙
Taxes: Federated’s marginal tax rate is Tc = .21
Solution:
E= 105000000 =2500000*42 (Market Capitalization)
D= 67500000 =75000000*90%
We= 0.60869565217 =B7/(B7+B8)
Wd= 0.39130434783 =1-B9
YTM= 9%
Tc= 21%
Kd= 7.1100% =B11*(1-B12) (before tax cost of debt*(1-Tc)
Ke= 18%
WACC= We*Ke+Wd*Kd
WACC= 13.739% =B9*B14+B10*B13
ollowing information:

tock is 18%. ∙
 19.14

Consider a project lasting one year only. The initial outlay is $1,000, and the expected inflow is $1,200. The opportunity cost o
The borrowing rate is rD = .10, and the tax shield per dollar of interest is Tc = .21.
a. What is the project’s base-case NPV?
b. What is its APV if the firm borrows 30% of the project’s required investment?
Solution:
APV=NPV with 0 debt + PVFS(Present value of financial side effects)

FCFF at T0= -1000

FCFF at T1= 1200
Ku or Ro= 20%
Base Case NPV=Inv0+Inv1/(1+Ku) 0.00 =B10+B11/(1+B12)
Rb or Rd= 10%
Tax Rate 21%
PVFS=PVITS
ITS at T1=Debt at T0*Interest*Tax
Borrowing 300 =30%*1000
ITS=Borrowing*Rb*Tax 6.3 =B18*B14*B15
PVITS=ITS/(1+Rb) 5.7273 =B19/(1+B14)

APV=Base case NPV+PVFS 5.7273 =B13+B20

0. The opportunity cost of capital is r = .20.
RWJ 3
Pompeii Pizza Club owns three identical restaurants popular for their specialty pizzas. Each restaurant has a debt-equity ratio o
interest pay_x0002_ments of $42,000 at the end of each year. The cost of the firm’s levered equity is 19 percent. Each store e
be $1.275 million; annual cost of goods sold will be $745,000; and annual general and administrative costs will be $405,000.
These cash flows are expected to remain the same forever. The corporate tax rate is 22 percent.
a. Use the flow to equity approach to determine the value of the company’s equity.
b. What is the total value of the company?
 urant has a debt-equity ratio of 40 percent and makes
uity is 19 percent. Each store estimates that annual sales will
ative costs will be $405,000.
19.5
Whispering Pines Inc. is all-equity-financed. The expected rate of return on the company’s shares is 12%.
a. What is the opportunity cost of capital for an average-risk Whispering Pines investment?
b. Suppose the company issues debt, repurchases shares, and moves to a 30% debt-to-value ratio (D/V = .30).
What will be the company’s weighted-average cost of capital at the new capital structure? The borrowing rate is 7.5% and the
 o (D/V = .30).
borrowing rate is 7.5% and the tax rate is 21%.
19-12
Indicate whether the following statements are true or false by using the APV method.
a. Starts with a base-case value for the project.
1
0
b. Calculates the base-case value by discounting project cash flows, forecasted assuming all-equity financing, at the
1
0
c. Is especially useful when debt is to be paid down on a fixed schedule.
1
0
g all-equity financing, at the WACC for the project.
 19.19
Consider a project to produce solar water heaters. It requires a $10 million investment and offers a level after-tax cash flow of
The opportunity cost of capital is 12%, which reflects the project’s business risk.
a. Suppose the project is financed with $5 million of debt and $5 million of equity. The interest rate is 8% and the marginal tax
An equal amount of the debt will be repaid in each year of the project’s life. Calculate APV.
b. How does APV change if the firm incurs issue costs of $400,000 to raise the $5 million of required equity?
s a level after-tax cash flow of $1.75 million per year for 10 years.

ate is 8% and the marginal tax rate is 21%.

red equity?
19-24
Company valuation Chiara Company’s management has made the projections shown in Table below.
Use this table as a starting point to value the company as a whole. The WACC for Chiara is 12%, and the forecast long-run grow
The company, which is located in South Africa, has ZAR 5 million of debt and 865,000 shares outstanding. What is the value pe

Latest
Year Forecast
(in 1,000's) 0 1 2 3 4
1 Sales 40,123.00 36,351.00 30,155.00 28,345.00 29,982.00
2 Cost of Goods Sold 22,879.00 21,678.00 17,560.00 16,459.00 15,631.00
3 Other Costs 8,025.00 6,797.00 5,078.00 4,678.00 4,987.00
4 EBITDA (1 – 2 – 3) 9,219.00 7,876.00 7,517.00 7,208.00 9,364.00
5 Depreciation and Amortization 5,678.00 5,890.00 5,670.00 5,908.00 6,107.00
6 EBIT (pretax profit) (4 – 5) 3,541.00 1,986.00 1,847.00 1,300.00 3,257.00
7 Tax at 28% 991.48 556.08 517.16 364.00 911.96
8 Profit after Tax (6 – 7) 2,549.52 1,429.92 1,329.84 936.00 2,345.04
9 Change in Working Capital 784.00 -54.00 -342.00 -245.00 127.00
10 Investment (change in gross PP&E) 6,547.00 7,345.00 5,398.00 5,470.00 6,420.00
the forecast long-run growth rate after year 5 is 4%.
ding. What is the value per share

5
30,450.00
14,987.00
5,134.00
10,329.00
5,908.00
4,421.00
1,237.88
3,183.12
235.00
6,598.00
RWJ 15
APV, FTE, and WACC 
Summers, Inc., is an unlevered firm with expected annual earnings before taxes of $23.5 million in perpetuity.
The current required return on the firm’s equity is 11 percent and the firm distributes all of its earnings as dividends at the end
The company has 1.9 million shares of common stock outstanding and is subject to a corporate tax rate of 21 percent.
The firm is planning a recapitalization under which it will issue $35 million of perpetual 6 percent debt and use the proceeds to
a. Calculate the value of the company before the recapitalization plan is announced. What is the value of equity before the an
b. Use the APV method to calculate the company value after the recapitalization plan is announced. What is the value of equi
c. How many shares will be repurchased? What is the value of equity after the repur_x0002_chase has been completed? Wha
d. Use the flow to equity method to calculate the value of the company’s equity after the recapitalization.
in perpetuity.
arnings as dividends at the end of each year.
tax rate of 21 percent.
t debt and use the proceeds to buy back shares.
value of equity before the announcement? What is the price per share?
ced. What is the value of equity after the announcement? What is the price per share?
se has been completed? What is the price per share?
19.17. APV
Consider a perpetual project with initial investment of $1,000,000, and the expected cash inflow is $95,000 a year in perpetu
The opportunity cost of capital with all-equity financing is 10%, and the project allows the firm to borrow at 7%. The tax rate is
Use APV to calculate the project’s value.
a. Assume first that the project will be partly financed with $400,000 of debt and that the debt amount is to be fixed and perp
b. Then assume that the initial borrowing will be increased or reduced in proportion to changes in the market value of this pro
Explain the difference between your answers to (a) and (b)
w is $95,000 a year in perpetuity.
o borrow at 7%. The tax rate is 21%.

mount is to be fixed and perpetual.

in the market value of this project.