Maria Ciucă

Group 15

𝑟𝑖 = 𝑟𝑓 + β * (𝐸(𝑟𝑀𝑘𝑡) − 𝑟𝑓) = 5% + 1. 1 * (15% − 5%) = 16%

𝑈 𝐹𝐶𝐹0 26
𝑉 = 𝑟𝑖
= 0.16
= $162.5 million

PV(TS)0 = Profit tax rate*Debt = 35%*10 = $3.5 million

V0L = VU + PV(TS)0 = 162.5 + 2.5 = $166 million

𝐹𝐶𝐹0−𝐹𝐶𝐹1 26−22
𝑃𝑉(𝐹𝐷) = 𝑟𝑖
= 0.16
= $25 million

PV(TS)1 = Profit tax rate*Debt1 = 35%*45 = $15.75 million

V1L = VU + PV(TS)1 - PV(FD) = 162.5 + 15.75 - 25 = $153.25 million

The firm’s value is higher in the case where it has $10 million debt, so I would advise XYZ
that a debt level of $10 million would be the best option.
FCF1 = $12 million

𝐹𝐶𝐹1 12
𝑉𝑎𝑙𝑢𝑒 𝑜𝑓 𝑑𝑒𝑏𝑡 = 1.05
= 1.05
= $11.43 million

The firm will go bankrupt as it does not have enough money to pay back its debt.

Equity holders receive nothing, which means the value of the firm’s equity is 0.

38
𝑁𝑃𝑉 = 1.05
− 22 = $14.19 million

FCF = $38 million => $15 million goes to the debt holders and remaining the $23 million
goes to the equity holders
15
𝑉𝑎𝑙𝑢𝑒 𝑜𝑓 𝑑𝑒𝑏𝑡 = 1.05
= $14.28 million

23
𝑉𝑎𝑙𝑢𝑒 𝑜𝑓 𝑒𝑞𝑢𝑖𝑡𝑦 = 1.05
= $21.9 million

No, they will not be willing to provide the $22 million, because the NPV of this project for
them would be a negative one, $-0.1 million (21.9-22).
It is called a debt overhang or under-investment problem.