The following information provides the basis for performing a straightforward application of the adjusted present value (APV) model.

Unlevered cost of equity€” The rate of return required by stockholders in the company, where the firm has used only equity financing.
Borrowing rate€”the rate of interest the firm pays on its debt. We also assume that this rate is equal to the current cost of borrowing for the firm or the current market rate of interest.
Tax rate€”the corporate tax rate on earnings. We assume that this tax rate is constant for all income levels.
Current debt outstanding€”total interest-bearing debt, excluding payables and other forms of ­non-interest-bearing debt, at the time of the valuation.
Firm FCFs€” Net operating earnings after tax (NOPAT), plus depreciation (and other noncash charges), less new investments in net working capital less capital expenditures ( CAPEX) for the period. This is the free cash flow to the unlevered firm because no interest or principal is considered in its calculation.
Interest-bearing debt€” outstanding debt at the beginning of the period, which carries an explicit interest cost.
Interest expense€” Interest-bearing debt for the period times the contractual rate of interest that the firm must pay.
Interest tax savings€” Interest expense for the period times the corporate tax rate.
a. What is the value of the unlevered firm, assuming that its FCFs for year 5 and be-yond are equal to the year 4 free cash flow?
b. What is the value of the firm€™s interest tax savings, assuming that they remain con-stant for year 4 and beyond?
c. What is the value of the levered firm?
d. What is the value of levered firms€™s equity, assuming that the firm€™s debt is equal to its book value?

Transcribed Image Text:

Assumptions Unlevered cost of equity Borrowing rate Tax rate Current debt outstanding 12% 3% 30% $200.00 Yearn Firm FCFs Interest-bearing debt Interest expense Interest tax savings 100.00 200.00 16.00 4.80 120.00 150.00 12.00 3.60 $180.00 100.00 8.00 240 and Betond 200.00 50.00 4.00 1.20