Practice Problems - HAAS SCHOOL OF BUSINESS UNIVERSITY OF...

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H AAS S CHOOL OF B USINESS U NIVERSITY OF C ALIFORNIA AT B ERKELEY UGBA 103 A VINASH V ERMA P RACTICE P ROBLEMS 1. XYZ Company is considering its first and only project. Therefore, we shall be using value of the firm interchangeably with the value of the project. This project calls for an investment of $135 million. Suppose this amount has been raised and is at present held as cash. Therefore, before the project the value of assets is $135,000,000. Now, suppose the project is expected to generate sales of $90,000,000 per year. Annual cash costs account for 64% of the sales. For computational ease, these annual sales, costs, and, therefore income, are assumed to occur in perpetuity. Now, suppose we are further given that the corporate profits are taxed at 32%, and that if this project were undertaken by an all-equity firm, its cost of capital would be 13.5%. [That is, r UA = 13.5%.]. The firm has a target debt-to assets ratio of five-eighth, and expects to issue debt at 9% per year. Value the levered firm by both APV and WACC method and show that the two methods yield the same answer.
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