Using the WACC Method to Value Firms/Projects SMU Corp is considering selling one of its product lines. The product line is expected to generate free cash flows of $2 million per year, growing at a rate of 3% per year. SMU has an equity cost of capital of 10%, a debt cost of capital of 7%, a corporate tax rate of 21%, and a debt-equity ratio of 2. What is the levered (after-tax) value of this production line, assuming that it has average risk and the D/E ratio is constant?
Using the WACC Method to Value Firms/Projects SMU Corp is considering selling one of its product lines. The product line is expected to generate free cash flows of $2 million per year, growing at a rate of 3% per year. SMU has an equity cost of capital of 10%, a debt cost of capital of 7%, a corporate tax rate of 21%, and a debt-equity ratio of 2. What is the levered (after-tax) value of this production line, assuming that it has average risk and the D/E ratio is constant?
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
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Transcribed Image Text:Using the WACC Method to Value Firms/Projects
SMU Corp is considering selling one of its product lines. The product line is expected to
generate free cash flows of $2 million per year, growing at a rate of 3% per year. SMU
has an equity cost of capital of 10%, a debt cost of capital of 7%, a corporate tax rate of
21%, and a debt-equity ratio of 2. What is the levered (after-tax) value of this production
line, assuming that it has average risk and the D/E ratio is constant?
Transcribed Image Text:Problem 5
Using the principle of backward induction, please select the optimal project among
project 1, project 2, and the RiskFree project.
Redraw the decision tree in a separate piece of paper and annotate the expected values
at each node, cross out suboptimal branches, and annotate the NPV of Project 1, 2, and
RiskFree.
Ignore discounting (discount rate r = 0)
Attach your solution to this question
Payoff = $200
expand
%3D
Payoff = $120
%3D
contract
%09
expand
Payoff = $65
%3D
40%
Project 1 cost =
$120
Payoff = $80
contract
%3D
expand
Payoff = $300
%3D
Project 2 cost =
$110
30%
Payoff = $90
%3D
contract
%0%
Payoff = $80
Risk-free project
cost = $100
%3D
Payoff = $120
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