fact et of facts about Brower Inc. and the current economic Here is a environmen

Question

fact et of facts about Brower Inc. and the current economic Here is a environment 4. on U.S. Treasuries is 3.5% r uses its WACC as its hurdle rat e for average risk projects. prowr h argeted capital str r has a targeted capital structure of 40% debt and 60% equity rower just uses retained earnings to fina nce the equity part of its investments Bro wer's stock is selling for $25.00 per share and the stock has a Beta of.80 rower's long-term debt is financed with annual bonds. These 7% coupon bonds are currently trading at par. The equity market is expected to grow at 10.5% in the coming year. Brower's tax rate is 40%. Next year's dividend is expected to be 5% higher than this year's dividend of $1.00. Brower expects the business to grow 5% in the coming year. Brower is considering two mutually exclusive projects. They are considered equally risky and carry about the same risk as an average project the company would invest in. Project One has an initial investment of $10 million and would generate Free Cash Flows of $1.9 million per year for 10 years. Project Two requires an initial investment of $5 million and will generate no cash flows until the end of 5 years at which time there will be a single free cash flow of $9 million. , . · . What do you advise Brower to do? Please be as specific as possible and show financial justification for your recommendation

Explanation / Answer

Calculation of Re , using dividend discount method - Po = D1/(Re - G) Re = D1/Po + G Putting values - Re = 1(1.05)/25 +10.5 10.542 Also, Cost of debt(kd) - Price of bond = Pv of cash flows discounted at YTM When bond is traded at par YTM = coupon rate of bond Therefore Kd = 7% x (1-0.40) 4.20 Debt Equity ratio = 40:60 WACC = 10.542 x 0.4 + 4.20 x 0.6 6.7368 Under Free Cash flow Approach Value of firm = PV of FCFF discounted at WACC Option 1 - 1.9 x PVAF(6.7368%, 10 Years) 13.50869 Option 2 - 9 x PVIF(6.7368%, 5 Years) 6.496383 Option 1 should be selected as it increases more to the value of firm then option 2 Please provide feedback… Thanks in advance.. :-)

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