Answer Happy

Question 11 Vega Industries is considering a new project. The project is expected to increase Vega's free cash flow by £12 million the first year, and this cash flow is expected to decline at a rate of 0.5% per year from then on. The project will cost £130 million. Vega currently maintains a constant equity-to-debt ratio of 3, its corporate tax rate is 21%, its cost of debt is 5.5%, and its cost of equity is 10%. REQUIRED: i) How much equity does Vega need to issue to finance the project while maintaining its equity-to-debt ratio? (5 marks) ii) Does the value of existing equity change? Show your workings. (2 marks) iii) Suppose that the cost of the project was £30 million instead of £130 million. Calculate the dividend that could be paid to shareholders as a result of the project. (2 marks) iv) Calculate the free cash flow to equity of the project in year 3. (3 marks) v) Suppose that Delta Systems, a company operating in the same industry as Vega, has no debt initially (i.e., it is an all equity financed company). Delta's current market capitalization is £85 million. The management of the company has decided to add debt for the first time to its capital structure by borrowing £42 million in permanent debt. Delta's corporate tax rate is 21%; the tax rate on interest income is 24%; and the tax rate on equity income is 20%. What will Delta's levered value be? (3 marks)