8/3/2011 The Economics of Taxation Lecture 11: Taxation and Business Valuation: FTE approach International Accounting International Accounting and Taxation Master of Science (MSc) University of Liechtenstein, Vaduz Dr. Tanja Kirn D T j Ki Chair for Tax Management and the Laws of International and Liechtenstein Taxation Institute for Financial Services University of Liechtenstein, Vaduz The Economics of Taxation Taxation and Business Valuation: FTE approach Exercise Suppose Lucent Technologies has an equity cost of capital of 10%, market capitalization of $10. billion, and an enterprise value of $14. 4 billion. Suppose p $ , p $ pp Lucent’s debt cost of capital is 6. 1% and its marginal tax rate is 35%. a. What is Lucent’s WACC? b. If Lucent maintains a constant debt? equity ratio, what is the value of a project with average risk and the following expected free cash flows? c. If Lucent maintains its debt? equity ratio, what is the debt capacity of the project in part (b)? part (b)? d. What is the free cash flow to equity for this project? e.
What is its NPV computed using the FTE method? How does it compare with the NPV based on the WACC method? © 2011 Dr. Tanja Kirn – University of Liechtenstein – Vaduz 2 1 8/3/2011 The Economics of Taxation Taxation and Business Valuation: FTE approach Exercise In year 1, AMC will earn $2000 before interest and taxes. The market expects these earnings to grow at a rate of 3% per year. The firm will make no net investments (i. e. , g g %p y ( , capital expenditures will equal depreciation) or changes to net working capital.
Assume that the corporate tax rate equals 40%. Right now, the firm has $5000 in risk? free debt. It plans to keep a constant ratio of debt to equity every year, so that on average the debt will also grow by 3% per year. Suppose the risk? free rate equals 5%, and the expected return on the market equals 11%. The asset beta for this industry is 1. 11. © 2011 Dr. Tanja Kirn – University of Liechtenstein – Vaduz 3 The Economics of Taxation Taxation and Business Valuation: FTE approach Questions a.
If AMC were an all? equity (unlevered) firm, what would its market value be? b. Assuming the debt is fairly priced, what is the amount of interest AMC will pay next year? If AMC’s debt is expected to grow by 3% per year, at what rate are its interest payments expected to grow? c. Even though AMC’s debt is riskless (the firm will not default), the future growth of AMC’s debt is uncertain, so the exact amount of the future interest payments is risky. Assuming the future interest