ans-odd-problems-ch17

ans-odd-problems-ch17 - CHAPTER 17 VALUATION AND CAPITAL...

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CHAPTER 17 VALUATION AND CAPITAL BUDGETING FOR THE LEVERED FIRM Solutions to Odd-numbered Questions and Problems NOTE: All end-of-chapter problems were solved using a spreadsheet. Many problems require multiple steps. Due to space and readability constraints, when these intermediate steps are included in this solutions manual, rounding may appear to have occurred. However, the final answer for each problem is found without rounding during any step in the problem. Basic 1. a. The maximum price that the company should be willing to pay for the fleet of cars with all-equity funding is the price that makes the NPV of the transaction equal to zero. The NPV equation for the project is: NPV = –Purchase Price + PV[(1 – t C )(EBTD)] + PV(Depreciation Tax Shield) If we let P equal the purchase price of the fleet, then the NPV is: NPV = –P + (1 – .35)($120,000)PVIFA 10%,5 + (.35)(P/5)PVIFA 10%,5 Setting the NPV equal to zero and solving for the purchase price, we find: 0 = –P + (1 – .35)($120,000)PVIFA 10%,5 + (.35)(P/5)PVIFA 10%,5 P = $295,681.37 + (P)(0.35/5)PVIFA 10%,5 P = $295,681.37 + .2654P .7346P = $295,681.37 P = $402,482.01 b. The adjusted present value (APV) of a project equals the net present value of the project if it were funded completely by equity plus the net present value of any financing side effects. In this case, the NPV of financing side effects equals the after- tax present value of the cash flows resulting from the firm’s debt, so: APV = NPV(All-Equity) + NPV(Financing Side Effects) So, the NPV of each part of the APV equation is: NPV(All-Equity) NPV = –Purchase Price + PV[(1 – t C )(EBTD)] + PV(Depreciation Tax Shield)
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The company paid $375,000 for the fleet of cars. Because this fleet will be fully depreciated over five years using the straight-line method, annual depreciation expense equals: Depreciation = $375,000/5 Depreciation = $75,000 So, the NPV of an all-equity project is: NPV = –$375,000 + (1 – 0.35)($120,000)PVIFA 10%,5 + (0.35)($75,000)PVIFA 10%,5 NPV = $20,189.52 NPV(Financing Side Effects) The net present value of financing side effects equals the after-tax present value of cash flows resulting from the firm’s debt, so: NPV = Proceeds – Aftertax PV(Interest Payments) – PV(Principal Payments) Given a known level of debt, debt cash flows should be discounted at the pre-tax cost of debt R B . So, the NPV of the financing side effects are: NPV = $250,000 – (1 – 0.35)(0.08)($250,000)PVIFA 8%,5 – [$250,000/(1.08) 5 ] NPV = $27,948.97 So, the APV of the project is: APV = NPV(All-Equity) + NPV(Financing Side Effects) APV = $20,189.52 + 27,948.97 APV = $48,138.49 3. a. In order to value a firm’s equity using the flow-to-equity approach, discount the cash flows available to equity holders at the cost of the firm’s levered equity. The cash flows to equity holders will be the firm’s net income. Remembering that the company has three stores, we find: Sales $3,000,000 COGS 1,350,000
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ans-odd-problems-ch17 - CHAPTER 17 VALUATION AND CAPITAL...

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