Question

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?

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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