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Assignment # 2
FIN 711: Mergers & Acquisitions


Submitted to
Dr. Salim Batla
Submitted by
Amber Younas
Anum Malik
Haseeb Malik
Muhammad Iqrash Awan
Raima Sabeen
Tallat Mehmood






NUST Business School

1
Q1: What is the value of the project assuming that the form was entirely equity financed?
What are the annual projected free cash flows? What discount rate is appropriate?
The discount rate for the firm is needed to compute the value of the firm. Since the project is all
equity financed, unlevered cost of equity is calculated using the following formula:
R
u
= R
I

u
(R
m
R
I
)
Wheie,
R
u
= 0nleveieu Cost of Equity
R
I
= Riskfiee Rate of Retuin

u
= 0nleveieu Beta
(R
m
R
]
) = 0nleveieu Cost of Equity

Inserting the values,
R
u
= S%+1.S 7.2%= 1S.8%
Thus, appropriate discount rate for the project is 15.8%.

The free cash flows are calculated using the following formula:
FCF = EBIT(1 T) +Bepieciation Capital Expenuituies Change in Woiking Capital

Inserting values,
FCF
2002
= 12 +2uu Suu = $112
FCF
2003
= 81 +22S Suu = $6
FCF
2004
= 2u1 +2Su Suu = $1S1
FCF
2005
= SS9 +27S Suu = $S14
FCF
2006
= 48S +Suu Suu = $49S

Since the growth rate is constant from Year 2007 at 5% thus the horizon value is calculated
using the following formula:
Boiizon value of FCF
2006
=
49S (1 +u.uS)
(u.1S8 u.uS)
= $4812.S



2
Value of the project can now be computed as follow,
Ioluc o tc Pro]cct = 1Suu +
112
1u1S8
+
6
(1.1S8)
2
+
1S1
(1.1S8)
3
+
S14
(1.1S8)
4
+
49S +4812.S
(1.1S8)
5

Ioluc o tc Pro]cct = $1228.49

Q2: Value the project using the adjusted present value (APV) approach assuming that the
firm raise $750 thousand of debt to fund the project and keeps the level pf debt constant
in perpetuity.
We know,
API = PI o Cos Flows +PI o Iox SiclJ
We have already calculated,
PI o Cos Flows = $1228.49
Computing present value of tax shield using the following formula,
PI o Iox SiclJ =
k
d
I
k
d
= I = 7Su u.4u = $Suu
Where,
D = Debt
T = Corporate Tax Rate
Kd = Required Rate of Debt
Thus,
API = 1228.48 +Suu = $1S28.48
Q3: Value the project using the Weighted Average Cost of Capital (WACC) assuming the
firm maintains a constant 25% debt to value ratio in perpetuity?
If the firm maintains a constant debt to value ratio of 25% then WACC can be computed as
follows,
wACC = K
d
(1 t) w
d
+K
c
w
c


Since the firm is levered now thus required rate of return that is levered is now computed.
K
c
= R

+ [
c
(R
m
R

)
Where,
[
o
= [
J
w
J
+ [
c
w
c



3
[
c
=
[
o
[
J
w
J
w
c
=
1.5 (0.25 0.25)
0.75
= 1.92
Thus,
K
c
= 5%+ 1.92(7.2) = 15.12%
Pro]cct
i
s Ioluc = 1Suu +
112
1.1S12
+
6
(1.1S12)
2
+
1S1
(1.1S12)
3
+
S14
(1.1S12)
4
+
49S +S1SS.87
(1.1S12)
5

Pro]cct
i
s Ioluc = $147u