Question

Please help with part c) This hasnt been answered well in other similar problems on here because I think the expert doesnt have all the info on type of problem part c is. They do not want just one answer for the entire project, but have it broken down by year. I am not sure how they get the "leveraged value" to get to the debt capacity.

Suppose​ Alcatel-Lucent has an equity cost of capital of 10.5%​, market capitalization of $11.52 ​billion, and an enterprise value of $16 billion. Suppose​ Alcatel-Lucent's debt cost of capital is 6.8% and its marginal tax rate is 33%.

a. What is​ Alcatel-Lucent's WACC? (I already got 8.84%)

b. If​ Alcatel-Lucent maintains a constant​ debt-equity ratio, what is the value of a project with average risk and the expected free cash flows as shown​ Below (already got $85.92)

c. If​ Alcatel-Lucent maintains its​ debt-equity ratio, what is the debt capacity of the project in part ​(b​)? (see below for pic)

(Click on the following icon 2 in order to copy its contents into a spreadsheet.) 1 Year FCF ($ million) 0 - 100 2 105 3 65 51 c. If Alcatel-Lucent maintains its debt-equity ratio, what is the debt capacity of the project in part (b)? The debt capacity of the project in part (b) is as follows: (Round to two decimal places.) Year 1 2 3 Debt capacity $ million $ million $ million million S This is an example of how Question C above should be set up to answer the question. It doesnt want just 1 Debt capacity ratio, it wants it for all the years Year 0 1 2 3 FCF ($ million) -100 60 110 80 V ($ million) 207.01 166.92 72.98 0.00 D=dx V $68.31 $55.08 $24.08 $0.00

Answer 1

c) The debt capacity is calculated by calculating the Value of Levered firm at various years (by discounting the future cashflows at WACC) and then calculating the debt level by multiplying the % of debt which is to be maintained

In this case, d = % of debt = ($16 billion - $11.52 biillion)/$16 billion = 0.28

So, For Year 0, value of Levered firm = 51/1.0884+105/1.0884^2+65/1.0884^3 = $185.92 million

For Year 1, value of Levered firm = 105/1.0884+65/1.0884^2 = $151.35 million

For Year 2, value of Levered firm = 65/1.0884 = $59.72 million

For Year 3, value of Levered firm = 0

Debt capacity for year 0 = $185.92 million *0.28 = $52.06 million

Debt capacity for year 1 = $151.35 million *0.28 = $42.38 million

Debt capacity for year 2 = $59.72 million *0.28 = $16.72 million

Debt capacity for year 3 = 0