FINANCIAL MANAGEMENT: THEORY AND PRACT
FINANCIAL MANAGEMENT: THEORY AND PRACT
15th Edition
ISBN: 9781305632455
Author: BRIGHAM E. F.
Publisher: CENGAGE L
Question
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Chapter 21, Problem 7P

a)

Summary Introduction

To determine: Horizon value at year 3.

a)

Expert Solution
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Explanation of Solution

Compute the value:

Horizon Value at Year 3=FCFF3×(1+G)RsuG

HVU,3=$40(1.07)(0.130.07)=$713.33

Hence, the value is $713.33.

b)

Summary Introduction

To determine: Current unlevered value of operations

b)

Expert Solution
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Explanation of Solution

Formula to calculate unlevered value of operations:

Unlevered Value=(Present Value of FCFF1+Present Value of FCFF2+Present Value of FCFF3+ Horizon Value at Year 3)=((FCFF1×(PVF, 13%, Year 1))+(FCFF2×(PVF, 13%, Year 2))+(FCFF3×(PVF, 13%, Year 3))+(Horizon Value Year3×(PVF, 13%, Year 3)))

Calculation of unlevered value:

Unlevered Value=(($20 million×0.885)+($30 million×0.7831)+($40 million×0.6931)+($713.33 million×0.6931))=$17.70 million+$23.49 million+$27.72 million+$494.37 million=$563.29 million

Therefore, unlevered value of operations is $563.29 million.

c.

Summary Introduction

To calculate: Horizon value of tax shield at year 3

c.

Expert Solution
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Explanation of Solution

Formula to calculate horizon value of tax shield at year 3:

Horizon Value=Tax Shield×(1+G)RsuG

Calculation of horizon value:

Horizon Value=$4 million1×(1+7%)13%7%=$71.33 million

Therefore, horizon value of tax shield is $71.33 million.

Working Notes:

Calculate tax shield (TS) of expense:

Tax Shield for Year 1=Tax Rate×Interest Expense=40%×$8 million=$3.2 million1

Tax Shield for Year 2=Tax Rate×Interest Expense=40%×$9 million=$3.6million

Tax Shield for Year 3=Tax Rate×Interest Expense=40%×$10million=$4 million

d.

Summary Introduction

To calculate: Current value of tax shield

d.

Expert Solution
Check Mark

Explanation of Solution

Formula to calculate current value of tax shield:

Current Value=(Present Value of TS1+Present Value of TS2+Present Value of TS3+ Horizon Value of Tax Shield at Year 3)=((TS1×(PVF, 13%, Year 1))+(TS2×(PVF, 13%, Year 2))+(TS3×(PVF, 13%, Year 3))+(Horizon Value of Tax Shield at Year3×(PVF, 13%, Year 3)))

Calculation of current value:

Current Value=(($3.21 million×0.885)+($3.62 million×0.7831)+($43 million×0.6931)+($71.33 million×0.6931))=$2.83 million+$2.82 million+$2.77 million+$49.44 million=$57.86 million

Therefore, unlevered value of tax shield is $57.86 million.

e.

Summary Introduction

To calculate: Current total value

e.

Expert Solution
Check Mark

Explanation of Solution

Formula to calculate current total value:

Current Total Value=(Current Value of Operations+Current Value of Tax Shield)

Calculation of current total value:

Current Total Value=$563.29 million+$57.86 million=$621.15 million

Therefore, current value is $621.15 million.

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