Somid plc is considering a project that will contribute £5 million in free cash flows the first year, growing by 2% per year thereafter. The project will cost £40 million and will be financed with £20.88 million in new debt initially with a constant debt-to-equity ratio maintained thereafter. Somid has an equity cost of capital of 13% and a debt cost of capital of 5%. The firm maintains a debt-to-equity ratio of 50%. Somid’s corporate tax rate is 21%; the tax rate on interest income is 24%; and the tax rate on equity income is 20%.
- Calculate the NPV of the project using the Adjusted Present Value method.
- ii. Show that the NPV of the project calculated using the WACC method matches the result you obtained in part (i)?.
- Suppose that Matrix Systems, a company operating in the same industry as Somid, has no debt initially (i.e., it is an all equity financed company). Matrix has an equity cost of capital of 12% and a current market capitalization of £95 million. The company’s free cash flows are expected to grow at 3% per year forever. Matrix’s corporate tax rate is 36%. The management of the company has decided to add debt for the first time to its capital structure and to maintain a 50% debt-to-value ratio going forward. If Matrix’s debt cost of capital is 6%, what will Matrix’s levered value be?
