Problem 2103 Compressed APV Model with Constant Growth An un

Problem 21-03
Compressed APV Model with Constant Growth

An unlevered firm has a value of $800 million. An otherwise identical but levered firm has $60 million in debt at a 3% interest rate. Its cost of debt is 3% and its unlevered cost of equity is 11%. After Year 1, free cash flows and tax savings are expected to grow at a constant rate of 4%. Assuming the corporate tax rate is 35%, use the compressed adjusted present value model to determine the value of the levered firm. (Hint: The interest expense at Year 1 is based on the current level of debt.) Enter your answer in millions. For example, an answer of $1.2 million should be entered as 1.2, not 1,200,000. Do not round intermediate calculations. Round your answer to two decimal places.

$   million

Solution

VU = $800.00 Corporate tax rate = 35.00% g = 4.00% rd = 3.00% rsU = 11.00% Debt = $60.00 VL = VU + VTS VL = $800 + (3% x 35%x$60)/(11% - 4%) $809.00 Million