Question

QUESTION 1

You are trying to estimate the enterprise value of Firm X. Since this firm is private, you cannot directly estimate the firm’s cost of equity using its stock data. Fortunately, there is a similar firm, Firm Y, which is in the same industry with comparable operating risk characteristics. Assume that the CAPM holds. The risk-free rate is 2% and the market risk premium is 5%.

Firm Y has a debt-to-equity ratio of 3 and it plans to keep this ratio fixed. Firm Y’s equity beta is 6.6 and debt beta is 0.2. What is Firm Y’s unlevered equity beta?

	A.	8.6
	B.	0.3
	C.	0.1
	D.	1.8

QUESTION 2

What is Firm X’s unlevered equity beta?

	A.	1.8
	B.	8.6
	C.	0.1
	D.	0.3

QUESTION 3

Assume that Firm X’s cost of debt is 2.5%. What is Firm X’s debt beta?

	A.	1.8
	B.	0.3
	C.	0.1
	D.	8.6

QUESTION 4

Firm X has a debt-to-equity ratio of 4 and it plans to keep this ratio fixed. What is Firm X’s equity beta?

	A.	0.1
	B.	0.3
	C.	1.8
	D.	8.6

QUESTION 5

What is Firm X’s cost of equity?

	A.	10%
	B.	15%
	C.	45%
	D.	35%

QUESTION 6

If the corporate tax rate is 50%, what is Firm X’s WACC?

	A.	10%
	B.	45%
	C.	15%
	D.	35%

QUESTION 7

Suppose that you forecasted Firm X’s free cash flows for the next four years as follows:

	Year 1	Year 2	Year 3	Year 4
(1) Free cash flow	$1,100	$1,210	$1,331	$1,586
(2) Terminal value				??

You need to estimate the terminal value at year 4 based on the “exit” multiple approach. If Firm X’s EBIT at year 4 is expected to be $200.45 and Firm Y has an EV/EBIT multiple of 14, what is the terminal value?

	A.	$1,430.8
	B.	$2,806.3
	C.	$6,000
	D.	$7,000

QUESTION 8

What is Firm X’s enterprise value?

	A.	$1,430.8
	B.	$6,000
	C.	$2,806.3
	D.	$7,000

Answer 1

Ans 1) Unlivered equity beta can be found out by the following formula

Unlivered beta = levered beta /1+( 1-tax)(debt-eq)

Unlevered beta of firm Y = 6.8 /1+(1*3)

= 6.8/4 = 1.8

Hence option D is the answer.

Ans 2) Firm X unlevered beta will be the same as firm Y unlevered equity beta of 1.8 hence option A is correct.

Ans 3) Debt beta can be calculated as follows:

Kd = Rf - Bd(RM -RF(1-Tax))

Where Kd = cost of debt , Rf = Risk free rate

Bd = debt beta , RM = return on market

0.025 = 0.02- Bd (0.05)

0.025 -0.02 = Bd *0.05

0.005/0.05 = 0.1 hence option C is the answer

Ans 4) Firm X equity beta or unlevered beta is

Unlevered beta = levered beta /1+(1-tax ) ( debt equity Levered beta = Unlivered beta * [1+(1-tax)*debt*equity

Levered beta = 1.8 * [1+4] = 1.8 *5 = 9 hence option D is the right answer.