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1、Fin 203, Kihlstrom: Alternative DCF Approaches,1,Debt Financing and Harris Proposed Investment in a Shrimp Processing Plant: Introduction,These notes evaluate Harris proposed investment assuming that it will be financed with a $7 million loan and that after the investment the firms ratio of Debt to
2、Debt plus Equity will be .2 The terms of the loan are described below.,Fin 203, Kihlstrom: Alternative DCF Approaches,2,Introduction (continued),The information about the UFCF and the rates are taken from the information in the Harris case and from the information in the 1998 Economic Report of the
3、President.,Fin 203, Kihlstrom: Alternative DCF Approaches,3,Introduction (continued),In evaluating the project, we use the three approaches weve talked about: Discount UFCF at WACC Discount Flows to Equity at the return to equity APV: Discount UFCF at the unlevered return and discount interest tax s
4、hield at the return to debt,Fin 203, Kihlstrom: Alternative DCF Approaches,4,Introduction (continued),In the first approach the WACC will be computed from the unlevered return using a ratio of Debt to Debt plus Equity of .2. In the second approach the equity beta used to get the return to equity wil
5、l also be computed from the unlevered beta using a ratio of Debt to Debt plus Equity of .2. A debt beta consistent with the return to debt will also be used in this computation.,Fin 203, Kihlstrom: Alternative DCF Approaches,5,Introduction (continued),The second and third approach will be done in tw
6、o ways: First, all of the debt used to finance the project will be attributed to the project. Second, only $2 million of the debt used to finance the project will be attributed to the project.,Fin 203, Kihlstrom: Alternative DCF Approaches,6,Introduction (continued),What happens? When we use the fir
7、st approach, the project is a negative NPV project. When we use the two other approaches, the project is a positive (or almost +) NPV project when all of the debt is attributed to the project, but it is a negative NPV project when only $2 million of the debt is attributed to the project.,Fin 203, Ki
8、hlstrom: Alternative DCF Approaches,7,Rate Assumptions,Fin 203, Kihlstrom: Alternative DCF Approaches,8,Rate Assumptions (continued),Fin 203, Kihlstrom: Alternative DCF Approaches,9,Financing Assumptions,Project is entirely debt financed New debt of $7 million is issued in 1980 Interest rate is 13.5
9、% Interest only is paid from 1981 to 1985 In 1986 the loan is repaid and interest is paid After the project is added and the firm is debt financed the ratio of Debt to Debt plus Equity will be .2,Fin 203, Kihlstrom: Alternative DCF Approaches,10,Processing Plant Cash Flows UFCF ($000),The NPV of the
10、 UFCF computed using the WACC of 17.81% is -$922 thousand. Evaluating the project this way it looks like a negativeNPV project.,Fin 203, Kihlstrom: Alternative DCF Approaches,11,Loan Flows,The interest shown for 1981-86 is after tax interest,Fin 203, Kihlstrom: Alternative DCF Approaches,12,Flows to
11、 Equity,In deriving these flows to equity we attributed all of the new debt to the project and added the loan flows to the UFCF of the project. The NPV of these flows to equity computed at the equityreturn of 20.45% is $545 thousand. Evaluating the project this way, it looks like a positiveNPV proje
12、ct.,Fin 203, Kihlstrom: Alternative DCF Approaches,13,Loan Flows,Now only $2 million of the loan is attributed to the project. The interest shown for 1981-86 is after tax interest,Fin 203, Kihlstrom: Alternative DCF Approaches,14,Flows to Equity Again,In deriving these flows to equity we attributed
13、only 20% of the new debt to the project and, therefore, added only20% of the loan flows to the UFCF of the project. The NPV of these flows to equity computed at the equityreturn of 20.45% is -$1616 thousand. Evaluating the project this way, it again looks like a negative NPV project.,Fin 203, Kihlst
14、rom: Alternative DCF Approaches,15,APV,In each year the tax shield equals the taxes saved at 46% on the interest paidat 13.5% on the loan of $7 million. The NPV of these tax shields computed at thereturn on debt of 13.5% is $1713.81 thousand. The NPV of the UFCF computed using the unleveredreturn of
15、 19.62% is -$2015.89 thousand. The APV of the project is the sum of these presentvalues and equals -$302.09 thousand. Evaluating the project this way, it looks like a slightly negative NPV project.,Fin 203, Kihlstrom: Alternative DCF Approaches,16,APV (continued),Now only the tax shield on a $2 mill
16、ion loan is attributed to the project. In each year the tax shield equals the taxes saved at 46% on the interest paid at 13.5% on the loan of $2 million. The NPV of these tax shields computed at thereturn on debt of 13.5% is $489.66 thousand. When the present value of the tax shields is added tothe NPV of the UFCF computed using the unleveredreturn of 19.62% the APV of the project becomes-$1526 thousand. Evaluating the project this way, it looks like a much more negative NPV project.,
