This assignment requires posting spreadsheets with your calculation answers in Classes Assignments. You should submit one big spreadsheet with separate tabs for each problem or problem part. If one part requires an answer from a previous part that you could not solve, make an assumption about the required data. You must highlight your answers clearly in color or by notation.
Each question or part of a question is worth the points noted.
1. Suppose Lucent Technologies has $6.2 billion net debt and an enterprise value of $26.6 billion. Lucentâ€™s debt has a 3.5% coupon with 9 years and 265 days to maturity and trades at $85.00. Its marginal tax rate is 42%. The 10 year T bond rate is 2.48%, stock unlevered beta is 2.24, and the risk premium is 5.5%. Assume debt beta is not zero, use Fernandez formulas and compute final answers using at least 2 decimal places. Total 40 pts
a. What is Lucentâ€™s WACC? 10 pts
. If Lucent maintains a constant debt-equity ratio, what is the value of a project with average risk and the following expected free cash flows? 5 pts
Year
0
1
2
3
FCF
-2500
1500
2500
1400
c. What is Lucentâ€™s unlevered cost of capital? 5 pts
d. What is the APV value of the project? 10 pts
e. What is the free cash flow to equity and NPV under the FTE method? 10 pts
2. Suppose Netflix is considering to purchase $5 million of equipment. This equipment will qualify for five years accelerated depreciation beginning in the same year as the capital expenditure. Netflix estimates its marginal federal and state tax rate to be 40% Suppose Netflix has a 7% bo
owing rate and the lease payments beginning of each year are $0.9 million for a lease term of 5 years. The equipment can be disposed for 10% of its original value at the end of the five years. Total 20 pts
a. For purchase, what are the depreciation, tax shield and free cash flows? 5 pts
. For leasing, what are the lease, tax effect and free cash flows? 5 pts
c. Compute the NAL. Should Netflix buy or lease this equipment? 5 pts
d. What is the
eakeven residual value? 5 pts
3. Consider the following information regarding the Fama French Carhart four factor model:
Factor Portfolio
Average Monthly Return (%)
IBM Factor Betas
GE Factor Betas
Wal-Mart Factor Betas
Rm - rf
0.42
0.712
0.937
0.782
SMB
0.18
-0.133
-0.214
0.224
HML
0.61
0.124
0.254
0.123
PR1 YR
0.66
0.276
-0.147
0.447
Using the FFC four factor model and the historical average monthly returns, what is the expected monthly excess return over risk-free rate for IBM, GE and Walmart? 5 pts
4. Your firm is planning to invest in an automated packaging plant. Ha
urtin Industries is an all-equity firm that specializes in this business. Suppose the tax rate is 40%, Ha
urtinâ€™s unlevered beta is 1.95, the risk-free rate is 2%, and the market return is 6.7%. Use Fernandez formulas that assume beta for debt is not zero for levered and unlevered cost of capital. Compute final answers using at least 3 decimal places. 25 pts
a. If your firmâ€™s project is all equity financed, estimate its cost of capital. 5 pts
. You decided to look for other comparables to reduce estimation e
or in your cost of capital estimate. You find a second firm, Thu
inar Design, which is also engaged in a similar line of business. Thu
inar has a stock price of $20 per share, with 25 million shares outstanding. It also has $100 million market value in outstanding debt, with a yield on the debt of 4.5%. Thu
inarâ€™s equity beta is 1.50. Estimate Thu
inarâ€™s unlevered beta. 5 pts
c. What unlevered beta would you use to estimate the cost of capital for Ha
urtinâ€™s project? 5 pts
d. You wish to finance this project with 40% debt to equity ratio and Ha
urtin can bo
ow at the same rate as Thu
inar. Compute the projectâ€™s cost of equity. 5 pts
e. What is your estimate for the cost of capital of your firmâ€™s project? 5 pts
5. Dynamic Energy Systems is cu
ently trading for $50 per share. The stock pays no dividends. A one-year European put option on Dynamic stock with a strike price of $41 is cu
ently trading for $12.47. You cu
ently hold 10 puts and bo
owed $ XXXXXXXXXXAssume the risk-free interest rate is 5% per year. Hint: Be extremely careful with cash flow signs. 10 pts
a. How you would hedge your position and what will be the cash flow when you hedge? 5 pts
. Demonstrate that the hedge works if the stock price is $70 at the end of the year. 5 pts
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