Question

Cagiati Enterprises has FCFF of $600 million. Cagiati’s before-tax cost of debt is 5.7%, and its required rate of return for equity is 11.8%. The company’s capital structure consisting of 20% debt and 80% equity. The tax rate is 33.33%, and FCFF is expected to grow forever at 5.0%. Firm’s total debt outstanding with a market value of $2200 million. What is the cash flow valuation of the firm’s equity? Select one:

a. $9975.3m b. $9915.3m c. $9985.3m d. $9965.3m

Answer 1

The cash valuation of the firm's equity is computed as shown below:

= Current FCFF (1 + growth rate) / [ (WACC - growth rate) ]

WACC is computed as follows:

= cost of debt x (1 - tax rate) x weight of debt + cost of equity x weight of equity

= 0.057 x (1 - 0.3333) x 0.20 + 0.118 x 0.80

= 10.2% or 0.102

So, the value of the company will be:

= $ 600 million [ (1 + 0.05) ] / (0.102 - 0.05)

= $ 630 million / 0.052

= $ 12,115.38462 million

So, the value of the firm's equity will be computed as follows:

= $ 12,115.38462 million - debt

= $ 12,115.38462 million - $ 2200 million

= $ 9,915.3 million Approximately

So, the correct answer is option b.

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