Problem Set #9  Solutions
GSI: Florent Rouxelin
182.
Suppose Caterpillar, Inc., has 665 million shares outstanding with a share price of $74.77, and $25
billion in debt. If in three years, Caterpillar has 700 million shares outstanding trading for $83 per
share, how much debt will Caterpillar have if it maintains a constant debtequity ratio?
E = 665 million × $74.77 = $49.7 billion, D = $25 billion, D/E = 25/49.722 = 0.503.
E = 700 million × $83.00 = $58.1 billion. Constant D/E implies D = 58.1 × 0.503 = $29.2 billion.
1810.
Consider Lucent’s project in Problem 5.
a.
What is the free cash flow to equity for this project?
b.
What is its NPV computed using the FTE method? How does it compare with the NPV based on
the WACC method?
a.
Using the debt capacity calculated in problem 5, we can compute FCFE by adjusting FCF for aftertax
interest expense (D
r
D
(1
–
tc)) and net increases in debt (D
t
–
D
t1
).
Year
0
1
2
3
D
46.47
37.91
16.13
0.00
FCF
$100.00
$50.00
$100.00
$70.00
Aftertax Interest Exp.
$0.00
$1.84
$1.50
$0.64
Inc. in Debt
$46.47
$8.55
$21.78
$16.13
FCFE
$53.53
$39.60
$76.72
$53.23
b.
2
3
39.60
76.72
53.23
NPV
53.53
$85.86
1.10
1.10
1.10
1816.
Tybo Corporation adjusts its debt so that its interest expenses are 20% of its free cash flow. Tybo is
considering an expansion that will generate free cash flows of $2.5 million this year and is expected to
grow at a rate of 4% per year from then on. Suppose Tybo’s marginal corporate tax rate is 40%.
a.
If the unlevered cost of capital for this expansion is 10%, what is its unlevered value?
b.
What is the levered value of the expansion?
c.
If Tybo pays 5% interest on its debt, what amount of debt will it take on initially for the
expansion?
d.
What is the debttovalue ratio for this expansion? What is its WACC?
e.
What is the levered value of the expansion using the WACC method?
This preview has intentionally blurred sections. Sign up to view the full version.
View Full Document
This is the end of the preview.
Sign up
to
access the rest of the document.
 Spring '07
 Berk
 Strike price, Option style

Click to edit the document details