Financial Questions. Accounting, Finance, SPSS Case Study

Corporate Financial Strategy (FINA-4740-91)
Midterm exam #1
Assumptions and definitions:
Marginal tax rate: 40%
Debt beta: 0.00
Risk-free rate: 4.93%
EMRP: 5%
Cost of debt: 6%
Target D/V ratio: 20%
Terminal growth rate (after 2011): 2.78%
t = 0: year 2006
NWC = Current assets (including cash and equivalents) – current liabilities
Problems:
1 Estimate unlevered free cash flows each year from 2007 to 2011, using Liedtke’s base case projections (Exhibits 6 & 7). (8 marks)
In order to find the Free Cash Flows (FCFs) of the company from the years 2007 to 2011, the FCF formula as provided below was used.
First, the change in NWC was derived by taking the company’s current assets and subtracting the current liabilities. Second, exhibit no. 6 shows the other pertinent information that can be used such as the capital expenditures and the depreciation. Finally, changes in WC was derived based from exhibits no. 7 and no. 4 for the period of 2007-2011 and 2006, respectively. After computing them on excel, the FCFs are as follows.
2 Why is there no deduction of interest expense in Question (1)? Does EBIT(1-t) overstate the tax burden? (8 marks)
The reason why there is no deduction of interest expense in question 1 is because the computation of the FCFF does not include after-tax interest. Specifically, in FCFF, the cost of capital is computed after-tax. This is to prevent redundancy of the interest tax savings. Prevention of the redundancy in interest in tax savings is important because it could cause a different FCFF due to the sa...