Suppose Alcatel-Lucent has an equity cost of capital of 10.3%, market capitaliza

Question

Suppose Alcatel-Lucent has an equity cost of capital of 10.3%, market capitalization of $11.20 billion, and an enterprise value of $16 billion. Suppose Alcatel-Lucent's debt cost of capital is 5.5% and its marginal tax rate is 35%.

a. What is Alcatel-Lucent's WACC?

b. If Alcatel-Lucent maintains a constant debt-equity ratio, what is the value of a project with average risk and the expected free cash flows as shown below?

c. If Alcatel-Lucent maintains its debt-equity ratio, what is the debt capacity of the project in part (b)?

Please show all work.

Explanation / Answer

a)

Wd = (16 - 11.2) / 16 = 30%

We = 11.2 /16 = 70%

WACC = 30%*5.5%*(1-35%) + 70%*10.3% = 8.2825%

b)

Value = -100 + 46 / (1+8.2825%) + 98 / (1+8.2825%)^2 + 71/ (1+8.2825%)^3 = 81.9850

c)

Debt capcity = 30%*100 = 30

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