Question

Suppose that you have following information about the company:

- The company has 2 billion shares outstanding

- The market value of its debt is € 4 billion

- The free cash flow to the firm is currently € 1.2 billion

- The equity beta is 0.9; the equity (market) risk premium is 7.5%; the risk-free rate is 3.5%

- The before-tax cost of debt is 7%

- The tax rate is 20%

- The company is currently and in the future financed 25% with debt

- The growth rate of the free cash flow to the firm is 4%

Calculate the following:

a) Weighted average cost of capital (WACC)

b) Value of the firm

c) Total market value of equity and value per share

Answer 1

a

Weight of equity = 1-D/A

Weight of equity = 1-0.25

W(E)=0.75

Weight of debt = D/A

Weight of debt = 0.25

W(D)=0.25

Cost of equity

As per CAPM

Cost of equity = risk-free rate + beta * (Market risk premium)

Cost of equity% = 3.5 + 0.9 * (7.5)

Cost of equity% = 10.25

After tax cost of debt = cost of debt*(1-tax rate)

After tax cost of debt = 7*(1-0.2)

= 5.6

WACC=after tax cost of debt*W(D)+cost of equity*W(E)

WACC=5.6*0.25+10.25*0.75

WACC =9.09%

b

firm or enterprise value = FCF in 1 year/(WACC - growth rate)

Firm/enterprise value = 1.2/ (0.0909 - 0.04)

Firm/enterprise value = 23.58

c

Enterprise value = Equity value+ MV of debt

23.58 = Equity value+4

Equity value = 19.58

share price = equity value/number of shares

share price = 19.58/2

share price = 9.79

c