Question

3. Answer part A and B. A. Suppose Gold Technologies has an equity cost of capital of 10%, market capitalization of $10.8 billion, and an enterprise value of $14.4 billion. Also, in years 1, 2, and 3, interest tax shields are 0.99, 0.81, and 0.34, respectively. Suppose Gold Technologies debt cost of capital is 6.1% and its marginal tax rate is 35%. Project free-cash flows (FCF) are given by: Year 2 FCF -100 100 50 70 What is Gold Technologies WACC? If Gold Technologies maintains a constant debt- equity ratio, what is the value of a project with average risk? What is Gold Technologies unlevered cost of capital? What is the unlevered value of the project? Show that the APV of Gold Technologies project matches the value computed using the WACC method. 2 3. B. Paddy Plc paid S0.20 per share as dividend (DPS) last year. This year's earnings per share (EPS) are $0.40. What will this year's dividend payment be if the firm has a target payment ratio of 75%, but likes to adjust to a new payment level at a rate of 75%?

Answer 1

You have asked two unrelated question. Further Q - 1 has multiple sub parts. Hence i will address all the sub parts of first question only. Please post the balance question separately.

Part (1)

All financials below are in $ billion.

Market value of equity, E = market capitalization = 10.8;

Market value of Debt, D = Enterprise value - equity = 14.4 - 10.8 = 3.6

WACC, r = D / (D + E) x Kd x (1 - T) + E / (D + E) x Ke = 3.6 / 14.4 x 6.1% x (1 - 35%) + 10.8 / 14.4 x 10 = 8.49%

Value of the project = PV of all FCF at r = 50 / (1 + r) + 100 / (1 + r)² + 70 / (1 + r)³ = 50 / (1 + 8.49%) + 100 / (1 + 8.49%)² + 70 / (1 + 8.49%)³ = 185.86

Part (2)

Unlevered cost of capital, r_U = D / (D + E) x Kd + E / (D + E) x Ke = 3.6 / 14.4 x 6.1% + 10.8 / 14.4 x 10 = 9.025%

Unlevered value of project = = 50 / (1 + r_U) + 100 / (1 + r_U)² + 70 / (1 + r_U)³ = 50 / (1 + 9.025%) + 100 / (1 + 9.025%)² + 70 / (1 + 9.025%)³ = 184.01

Part (3)

PV of interest tax shield = 0.99 / (1 + r_U) + 0.81 / (1 + r_U)² + 0.34 / (1 + r_U)³ = 0.99 / (1 + 9.025%) + 0.81 / (1 + 9.025%)² + 0.34 / (1 + 9.025%)³ = 1.85

Value of levered firm = Value of unlevered firm + PV (interest tax shield) = 184.01 + 1.85 = 185.86

Thus the value of levered firm calculated in Part (3) = 185.86 = value of levered firm calculated in Part (1) above.

Thus, the APV of Gold Technologies project matches the value computed using the WACC method.