Question

Mastrade firm has free cash flow of 3,500,000 USD. When the firm was unlevered it had...

Mastrade firm has free cash flow of 3,500,000 USD. When the firm was unlevered it had a cost of equity of 9%. Then it went for permanent leverage by borrowing 500,000 USD at 8% interest rate. Corporate tax rate 40%. What is the WACC of the company? If FCF increase to 4 million next year, what will be the value of Mastrade firm?

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Answer #1

Solution:

a)Calculation of WACC

Valur of equity=Free cash flow/Cost of equity

=$3,500,000/0.09

=$38,888,889

Value of debt=$500,000

Total market value of capital=$38,888,889+$500,000

=$39,388,889

WACC=(Cost of equity*Value of equity/Total market value of capital)+[Cost of debt(1-tax rate)*Value of debt/Total market value of capital]

=[9%*($38,888,889/$39,388,889)]+[8%(1-0.40)*$500,000/$39,388,889]

=8.95%

b)Calculation of value of Mastrade firm

Value of Mastrade firm=Next Year FCF/WACC

=$4000,000/0.0895

=$44,692,737.43

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