Finger Enterprise has the opportunity to invest $2 million today and expects after tax cash flows of $1.2 million at time 1, and 1.4 million at time 2. The appropriate cost of capital for all-equity financing is 12%, the debt cost is 8%, and FE’s target debt ratio for projects of this type is 40% (D/V). Assume tax shields have a net value of $.25 per dollar of interest paid. Calculate the projects value using each of the following methods.
a. Assume that debt ratios are fixed in terms of book value and value the project according to APV.
b. Use the M&M adjusted cost of capital.
c. Assume that debt ratios are fixed in terms of market value and redo part a.
d. Which number do you feel most confident with, and why?