QUESTION 76 For the next 8 questions suppose the following data. The Also Horns

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QUESTION 76

For the next 8 questions suppose the following data.

The Also Horns Corp. is planning on introducing a new line of saxophones. They expect sales to be $400,000 with total fixed and variable costs representing 70% of sales. The discounted rate of the unlevered equity is 17%, but the firm plans to raise $144,385 of the initial $450,000 investment as 9% perpetual debt. The corporate tax rate is 40% and the target debt to asset (or value) ratio is 0.3.

In addition to the information above, suppose the APV approach is used to evaluate the project for the next 4 questions.

How much is the unlevered cash flow?

$72,000

$84,000

$100,000

$120,000

$144,000

1 points   

QUESTION 77

What is the NPV of the project to an all-equity firm?

$-34,451

$-26,471

$-12,417

$25,376

$34,451

1 points   

QUESTION 78

What is the NPV of the financing side effects (NPVF)?

$44,334

$57,754

$62,250

$65,000

$75,250

1 points   

QUESTION 79

What is the APV of the project?

$12,341

$27,799

$31,283

$35,779

$45,337

1 points   

QUESTION 80

Suppose the FTE approach is used to evaluate the project for the next 3 questions.
Use the information in Problem 76,

How much is the levered cash flow?

$42,250

$48,000

$55,236

$64,203

$70,520

1 points   

QUESTION 81

What is the rS, discount rate for the equity of the levered firm?

16.25%

18.14%

19.06%

19.67%

20.20%

1 points   

QUESTION 82

What is the Initial Net Equity Investment?

$200,000

$225,500

$250,500

$275,500

$305,615

The Also Horns Corp. is planning on introducing a new line of saxophones. They expect sales to be $400,000 with total fixed and variable costs representing 70% of sales. The discounted rate of the unlevered equity is 17%, but the firm plans to raise $144,385 of the initial $450,000 investment as 9% perpetual debt. The corporate tax rate is 40% and the target debt to asset (or value) ratio is 0.3.

Explanation / Answer

Unlevered Cash Flows : 400000 * (1-70%) = 120000. Taxes = 40%; Net of Tax cash flows = 72000

NPV : -450000 + 72000/(1+17%) = -26471

Financing benefit : NPV (terminal value) interest tax shield = Tax rate * debt = 40% 144385 (since the debt is given as perpetual debt). = 57754

APV = 57754 - 26471 = 31283

FTE approach :

Cash flow to equity holders : [400000 * (1-70%) - 144385 * 9% ] * (1-40%) = 64203

Rs = unlevered cost of equity + Debt / Equity * (1- tax rate) * (unlevered equity rate - debt cost)

Rs = 17% + 0.3/0.7 * (1-40%) * (17%-9%) = 19.06% (we have used 0.3 as debt to asset ratio hence d/e would be 0.3/0.7)

Initial Net Equity = 450000 - 144385 = 305615

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