Question

**Restex has a debt-equity ratio of 0.62, an equity cost
of capital of 14%, and a debt cost of capital of 11%. Restex's
corporate tax rate is 30%, and its market capitalization is $163
million.**

**a. If Restex's free cash flow is expected to be $3
million one year from now and will grow at a constant rate, what
expected future growth rate is consistent with Restex's current
market value?**

**b. Estimate the value of Restex's interest tax
shield.**

Answer #1

WACC = Cost of Equity * Weight of Equity + Cost of Debt after tax * Weight of Equity

= 14% * 1 / 1.62 + 11* (1-0.30) * 0.62 / 1.62

= 11.59%

Value of Levered Firm = 163 mn * 1.62 = 264.06 mn

OR

Value of Levered Firm = FCF / WACC - G

264.06 = 3 / 0.1159 - G

264.06 * 0.1159 - 264.06 * G = 3

G = 30.604554 - 3 / 264.06

**G =
10.45%**

b)

Value of Tax Shield is calculated by difference of Levered Value of Firm at WACC pre tax and post tax

Pretax WACC = Cost of Equity * Weight of Equity + Cost of Debt after tax * Weight of Equity

= 14% * 1 / 1.62 + 11 * 0.62 / 1.62

= 12.85%

Value of levered Firm = FCF / Pre tax WACC - G

= 3 / 0.1285 - 0.1045

= 125 mn

**Tax Shield =
264.06 - 125 = 139.06 mn**

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