Kellogg Finance – Prof Banerjee

Problem Set #6 Setting: A small video chain is deciding whether to engage in a new line of delivery business and is conducting an economic analysis of the valuation impact of this decision. This case requires you to value the project, with its debt capacity and the associated tax shields. Consider both WACC and APV methods. Case questions 1. What is the value of the project assuming the firm is entirely equity financed? What are the annual projected cash flows? What is the appropriate discount rate? 2. Value the project using the APV approach, assuming the firm raises $750,000 in debt to fund the project and keeps that level fixed in perpetuity. 3. Value the project using the WACC approach assuming the firm maintains a constant D/V ration of 25% in perpetuity. 4. How do the two approaches in (2) and (3) compare? How do the assumptions on financial policy compare in the two approaches? 5. Given the assumptions, which do you think gives the more appropriate valuation of the project? The case materials give a very clear layout of the cash flow projections, required returns, tax rate, and other data. Additional assumptions: a) The initial start-up expense is made immediately. b) Cash flows arrive at the end of the year. c) Value the project as a perpetuity. You’ll need to calculate the terminal value of the project cash flows that continue after the projections given in the case materials.