Asset value

CFA Level II Equities
#1

Ham Co. is thinking to raise 100,000,000 in new equity for a new project. At the moment, there are 80,000,000 outstanding shares and the market price of each stock is 9.5. The new project is expected to produce a net income of $18,000,000 in the first year, and to have a constant EBITDA for the 8 years of its life. The new assets will be depreciated by 1/10 of their initial value every year. At the end of its life (that is, after the 8 years) the projects asset’s will be sold at their residual value. The company currently (that is, before starting the project) holds a $300,000,000 in debt. For the new project, the company plans to keep the same debt-to-equity ratio as the rest of the company and to keep it constant for the life of the project. The unlevered return on equity is 9% while the required return on debt is 3%, the corporate tax rate is 26% and the depreciation tax shield is as risky as the company’s debt.

a) What is the value of the new project’s assets?

Any help is greatly appreciated:)

#2

[simple way 1] company today 300m debt 80m * $9.5 = 760m debt/equity = 300/760 = 0.3947 with new project, debt = 0.3947 * (760 + 100) = 339m so project’s assets are 139m [simple way 2] calculate the wacc, wacc = 760/1060 * 0.09 + 300/1060 * 0.03 * ( 1 - 0.26) = 7.0811% NI 18m/yr DEP 14m/yr - tax shelter = 14 * 0.26 = 3.64m yr 8 sell for 28m plug into your 12c… 7 x 21.64 8th 48.64 NPV = 139m

#3

In the simple way 1, how do u find the value of the assets? Also, when I plug 21,64 in the 7 first years followed by 48,64 in the 8th year discounted by 7,0811 the NPV I get is 144,43.

#4

Set up your mini balance sheet.

A = L + E

Before project:

$1,060,000,000 = $300,000,000 + $760,000,000

After project:

New debt based on .3947 D/E ratio and +$100,000,000 equity = $339,442,000

A = L + E

A = $339,442,000 + $860,000,000

A = $1,199,442,000

A (after project) - A (before project) = New Assets

New Assets = $1,199,442,000 - $1,060,000,000 = $139,442,000

I’m not certain about the NPV calculation, but I think the WACC may be off due to the cost of equity used. The problem specifically states “unlevered”, which makes me think “MM Theory”, but then it says “return on equity”, which is not necessarily the cost of equity. I don’t know, I haven’t been able to get my head around this part, but I know the IRR needs to be about 8% for the NPV to match the asset value.

#5

sorry guys, i did it on the calculator first then wrote the post doing each step separately. The sums seem very sensitive to rounding so please use full precision of your calculator when going through the steps.

i.e. the value is not 139m there are some more decimal points… divide this by 10 (dont use “14”) and use more decimal places for the WACC… trust me it works…