Quiz 2a: Casco in problem 1

FIN630 Summer 2012, Quiz 2

Problem 1
a. Market value of interest bearing debt
Interest expense = 50
Book value of debt = 1000
Pre-tax cost of debt = 7.50% ! Ignored time value of money: -1 point
Debt maturity 10 ! Used after-tax cost of debt: -0.5 points
Estimated market value = $828.40 ! Math errors: -0.5 point

b. Debt value of lease commitments

Lease obligations = 120
Years = 7
Pre-tax cost of debt = 7.50% ! Used after-tax cost of debt: -0.5 points
Estimated market value = $635.59 ! Math errors: -0.5 point

c. Cost of capital computation

Debt = $1,463.99 ! Leases are (off-balance sheet) debt.
Equity = 4000
D/E = 36.60%
Debt/EV = 26.79% ! Error in weights: -0.5 points

Unlevered beta = 1.2 ! Beta of entertainment business

Tax rate 40%
Levered beta = 1.4635 ! Used wrong beta: -1 point
Cost of equity = 11.78% ! Did not lever beta: - 0.5 point
After-tax cost of debt = 4.50% ! Used effective tax rate: -0.5 point
Cost of capital = 9.83% ! Did not after-tax cost of debt: -0.5 point

Problem 2
Year 0 Year 1-10 Year 10
Initial Investment (1,000,000)
Working Capital (20,000) 20,000 ! Ignored initial investment: -0.5 points
Revenue 200,000 ! Problems in working capital: -0.5 points
Expenses (40,000) ! Did not add back depreciation: -1 point
Depreciation (100,000) ! Other Cashflow calculation errors: -0.5 to -1 points
EBIT 60,000 ! Recommendation errors: -0.5 points
taxes 24,000
operating cashflow 36,000
add back depreciation 100,000
FCF -$1,020,000 $136,000 $20,000

cost of capital 8%
NPV -$99,718.06
No, don't take the project.

Problem 3 Year 0 Year 1- forever

Initial investment -$50.00 ! Used company's discount rate of 10% to discount project cashflow: -0.5 point
! Lease revenue from parking ignored/wrong: -0.5 point
Revenues $20.00 ! Fixed G&A counted/wrong: -.5 point
- Direct Expenses $8.00 ! Did not include capital maintenance (including ignored after year 10): -.5 points
- Incremental G&A $2.00 ! Counted salvage value and terminal value in PV: -0.5 point
- Lost lease revenue (from land) $1.00 ! Other errors: varies
- Depreciation $4.00
Operating income $5.00
- Taxes $2.00
After-tax operating income $3.00
+ Depreciation $4.00
 Quiz 2a: Casco in problem 1

- Capital maintenance $4.00

Cash flow $3.00

NPV = -$12.50

1. If you discounted the lost lease revenue separately using the company's cost of capital (instead of this project's cost of
capital), you should get full credit. In fact, the right discount right for lease revenues should be the pre-tax cost of debt of the
lessee.
2. I+A21f you estimated the cash flows for the first 10 years without a maintenance cap ex and introduced a cap ex after year 10, I
gave you full credit (even though I think you are starting too late). If you do this though, remember to bring your terminal
value back ten years. Your NPV will be as follows:
NPV = -50 + 7 (PVA, 10 years, 8%) + (3/.08) / 1.08^10
 Quiz 2a: Casco in problem 1

tion errors: -0.5 to -1 points

to discount project cashflow: -0.5 point

wrong: -0.5 point

including ignored after year 10): -.5 points

alue in PV: -0.5 point