FINC 560 Final Exam_Spring 2017 (Section 01)

You Name: ________

Your exam score: __________________________ out of 100%

Please read questions very carefully.

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from your excel work and paste in the exam, and you do not have to show
the excel formulae.
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exam.
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penalty per page if your exam is more than 6 pages. No additional
attachments for your solution.
Take-home Exam: 5:00pm 11:50pm on March 2nd, 2017
Email submission to kimd@montclair.edu by 11:55pm on Thursday
(3/2)
o Email subject: FINC 560_01_your last mane_Exam

1. (15pts) Your firm is considering expanding its household products division (100%
equity financed). You identify P&G as a firm with comparable investments.
Suppose P&Gs equity has an equity market capitalization of 150 billion and an
equity beta of 0.6. P&G also has $38 billion of AA rated debt outstanding
(assume that debt beta is zero), with an average yield of 3.5%. P&G has $2
billion of an excess amount of cash. Estimate the cost of capital of your
firms investment using the two different equations. A risk free rate of
3% and a market risk premium of 5% are given. (Use the net debt
concept)

Key Information:

rf: 3%
Beta: 0.6
rp: 5%
E D
Formula: 1) ri = rf + Beta x E [Rmkt] rf 2) ru= E+ D
+ rD
E+ D

re = 3%+ (0.6 x 5%) =6%

Net debt = 38billion 2billion = $36 billion

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rWACC = ((150/ (150+36) * 6%) + ((36) / (150+36)) * 3.5% =5.6%

2. (15pts) Hasco Corp. is a multinational provider of lumber and milling equipment.

Currently, Hascos equity cost of capital is 13% and its borrowing cost is 7%.
Hasco has a target leverage ratio of 35%. Hasco starts a new project which is
developing a GPS-based inventory tracking system, which will be a separate
division in Hasco. Management views the risk of this investment as similar to
that of other technology companies investment. Suppose Hasco plans to
finance the new division using 15% of debt financing (a constant debt value ratio
of 15%) with a borrowing cost 8%, and its corporate tax rate is 35%. You have
the following information about the comparable company to the new Hascos
technology investment.
(Comparable company: leverage ratio 20%, cost of equity 14%, cost of debt
10%, tax rate = 35%.)
(5pts) Estimate the cost of capital of Hasco Corp (using traditional WACC
equation)

WACC = (0.13*0.65) + 0.07*0.35(1 - 0.35) = 10.04%

(10pts) Estimate the cost of capital of the new investment (using the two
different equations for the cost of capital, which are traditional WACC
equation and project based WACC equation.

traditional WACC = (0.14*0.80) + 0.07*0.20(1-0.35) = 10.29%

project based WACC equation = 0.1029 - 0.07/0.13 (0.35) * 0.10 = 8.29%

3. (20 pts) Suppose Lucent has cost of equity of 9%, equity market capitalization of
$10 billion, and total debt 4 billion and 0.4 billion of excess amount of cash.
Suppose Lucents cost of debt is 6% and its marginal tax rate is 35% (Note: Use
Net Debt concept (ND) and leverage ratio = ND/(ND+E)).

#Question 1 (5pts): What is Lucents WACC (after tax)?

Key information
ru=9%
E=10 Billion
D=4 Billion
Tc=35%
rd = 6%

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 Excess cash = 0.4 billion, then, NET Debt = 4-0.4 = 3.60 Billion

WACC after tax= 9%*10/(10+4-0.4) + 6%*(4-0.4)/(10+4-0.4)*(1-35%)

=7.65%

#Question 2 (5pts): If Lucent maintains a constant leverage ratio, what is the

value of a project with average risk and the following expected free cash
flows ($millions)? NPV analysis using WACC method

Free Cash Flows: -120 (t=0), 60 (t=1), 100 (t=2), 80 (t=3)

NPV= -120+60/ (1+7.65%) + 100/ (1+7.65%)^2 + 80/(1+7.65%)^3 =

$86.16

#Question 3 (5pts): If Lucent maintains its leverage ratio, what is the debt
capacity of the project in the previous question? (use the Leverage ratio in
Question 3.1)

Year 0 1 2 3
FCF -120 60 100 80
VL 200.68 160.60
74.31 0
D = d*VL 52.18 41.76
19.32 0

Question.4(5pts): Perform NPV analysis using APV method using information

from the previous questions

APV = -120+(60/(1+9%))+100/(1+9%^2)+80/(1+9%^3) = -120 + 55.05 + 84.17 +

61.77 = $80.99

4. Optional question (20 points)

You are a partner of Private Equity Firm, Lion LLC (Acquiring firm) and you have
the following information for the acquisition of the firm, ABC Corp (target firm),
which is currently your project. The target firm is a private firm.
Suggested bidding price for the target = $147 million
Comparable firms of the target firm: unlevered cost of capital = 6.54%
Five year estimation of free cash flow to the firm (FCF) and interest tax
shields
o FCF: 13 million (t=1), 7.4 million (t=2), -5.8 million (t=3), 1.4 million
(t=4), and 10.3 million (t=5)

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 o Pre-determined Interest tax shields: $2.3 million at t=1, $2.3 million at
t=2, $2.3 million at t=3, $2.7 million at t=4, $2.8 million at t=5
(assuming that cost of debt is 7% for the target firm and this rate is for
the PV of tax shield)
Estimation of FCF at t=6 is $11 million (after t=6 and beyond, FCF will grow
at the constant growth rate = 5% and cost of capital = 9%)

Question : Perform NPV analysis for this project using APV method. (You should
include discounted cash flows for five years as well as continuation value)

Adjusted present value of the project = Unlevered NPV of free cash flows for 5 years
+ NPV of assumed terminal (or continuation) value + NPV of pre-determined
interest tax shield for 5 years

To calculate the NPV of FCFF

Suggested bidding price of $147 million

FCFF Estimated = 13 million (t = 1), 7.4 million (t = 2), -5.8 million (t = 3), 1.4
million (t = 4), and 10.3 million (t = 5)

Unlevered cost of capital= 6.54%,

NPV = $-124.48 million

PV Calculation

11 (1 + 0.05)/9%- 5% = $288.75 million

PV = $172.17 million

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NPV of interest tax shields for 5 years

interest tax shields: $2.3 million at t = 1, $2.3 million at t = 2, $2.3 million at t = 3,

$2.7 million at t = 4, $2.8 million at t = 5, and cost of debt= 7%

Total PV = $10.09 million

Adjusted present value of the project is, therefore, -$124.48+ $172.17 + $10.09
= $57.78 million