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rs
pe
Pa
Corporate Finance
de
ra
pG
To
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Question No: 1
APV = NPV + NVP OF FINANCING
rs
At year 1:
NPV= -50+40/ (1+.12)1
pe
= -14.2857
NPV of financing = 50-(20+16)/ (1.08)1
=30
Pa
APV effect at year 1= -14.2857 + 30
= 15.7143
At year 2:
de
NPV= -50+40/ (1+.12)1+20/ (1+.12)2
=1.658
NPV of financing =50 - 21.6/ (1+.08)1-15.96/ (1+.08)2
ra
=16.3169
APV= 1.658 + 16.3169
pG
=17.9749
At year 3:
NPV= -50+40/ (1+.12)1+20/ (1+.12)2-25/ (1+.12)3
To
=19.4527
NPV of financing= 50-21.6/ (1+.08)1-15.96/ (1+.08)2-15.48/ (1+.08)3
=4.0283
APV=19.4527 + 4.0283
=23.4810
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Question No: 2
At year 0
rs
Cost of equity =12%
Cost of debt= 8% Tax rate=40%
I- Equity=0 debt=100%
pe
= (0*.12) + (1*.08*.6)
=.048 =4.8%
Pa
At year 1
II- Equity= 40% debt=60%
= (20/50) * .12 + (30/50)*.08*.6
de
=.048 + .0288
=.0768 =7.68%
At year 2
ra
III- Equity=70% debt =30%
= (35/50)*.12 + (15/50)*.08*.6
pG
=.084+.0144
=.0984 =9.84%
At year 3
IV- Equity= 100% debt=0%
To
=1*.12 + 0*.08*.6
=.12 =12%
The WACC is increasing over time due to the increase inequity and reduction in debt amount.
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Question No: 3
NPV using WACC
rs
=-50+40/ (1+.0768)1+20/ (1+.0984)2+25/(1+.12)3
=-50+37.1471+16.5771+17.7949
pe
NPV=21.5191
Question No: 4
Pa
Assumption: finding cost of capital using Miller & Modigliani
Rs=Ro+ (B/S) (Ro-Rb) (1-Tc)
Where r0 = the required return on the equity of an unlevered firm
rS = the required return on the equity of a levered firm
de
rB = the pre-tax cost of debt
TC = the corporate tax rate
B = the market value of the firm’s debt
ra
S = the market value of the firm’s equity
Year 1
pG
=.12+1.5*.04*.6
=.1560=15.60%
Year 2
=.12+.43*.04*.6
To
=.1303 =13.03%
Year 3
=.12+0*.04*.6
=.12 =12%
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Question No: 5
rs
FTE method
Year 3
=-50+40/ (1+.1560)1+20/ (1+.1303)2+25/ (1+.12)3
pe
=24.6179
Pa
The NPV using FTE method is more than the method used in WACC and initial NPV.
de
ra
pG
To
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