Mini Case: The Link between Capital Structure and Capital Budgeting
Fiera Corporation is evaluating a new project that costs $45,000. The project will be financed using 40% debt and 60% equity, thus maintaining the firm's current debt-to-equity ratio. The firm's stockholders have a required rate of return of 18.36%, and its bondholders expect a 10.68% rate of return. The project is expected to generate annual cash flows of $13,000 before taxes for the next two decades.
Fiera Corporation is in the 36% tax bracket.
problem1. Determine the firm's weighted average cost of capital (WACC).
problem2. find out the traditional net present value (NPV) of the project using the WACC.
a. Should the project be undertaken?
problem3. Using Modigliani and Miller's Proposition II, determine the required return on unlevered equity.
problem4. Use adjusts present value (APV) method to determine whether or not the project should be undertaken.
problem5. Use the flow-to-equity (FTE) method to find out whether or not the project should be undertaken.