UNIVERSITY OF SOUTHERN CALIFORNIA
Marshall School of Business
INTERNATIONAL FINANCIAL MANAGEMENT
FBE 436
Aris Protopapadakis
ANSWERS TO PROBLEM
SET
# 3:
Problem #3.1:
Below is the relevant cash flow report for a project.
If the corporate tax rate is
34%
, the
Debt/Equity ratio is
1.00
, the Cost of Debt is
11.0%
and the
unlevered
Cost of Equity is
22.0
%
for this project, what is the Net Present Value?
What is the current
beta
of the firm’s equity,
assuming that
R
f
is
6.0%,
and the market risk premium,
ERP
m
, is
8.0%.
Year
1
2
3
Free Cash Flow
2,772.00
3,102.00
3,036.00
Interest Tax Shield
340.00
400.00
410.00
Answer:
Below are the discounted cash flows:
PV of the Cash Flows
Year
1
2
3
Free Cash Flow
2,272.13
2,084.12
1,671.95
Interest Tax Shield
306.31
324.65
299.79
Total Present Value:
$6,958.94
Free Cash Flow is discounted at 22% --
CoE
(
u
)--
and the interest tax shields are discounted at
11% --
CoD
.
We can
infer
the current equity beta by first calculating the
levered
CoE
,
CoE
(
L
), and then
reversing the CAPM equation.
Reverse the
CoE
(
u
) equation to get:
( )
( )
( )
[
]
(
)
E
D
CoD
u
CoE
u
CoE
L
CoE
c
τ
−
−
+
=
1
.

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