Question

Restex has a​ debt-equity ratio of 0.99​, an equity cost of capital of 16%​, and a debt cost of capital of 7%. ​Restex's corporate tax rate is 30%​, and its market capitalization is $287 million.

a. If​ Restex's free cash flow is expected to be $8 million one year from now and will grow at a constant​ rate, what expected future growth rate is consistent with​ Restex's current market​ value?

b. Estimate the value of​ Restex's interest tax shield.

Answer 1

Answer)

PART A)

Given

Debt-Equity ratio	0.99
Equity cost of capital	16%
Debt cost of capital	7%.
Tax	30%
Cash Flow	$8 Million
Market capitalization	$287 million.

WACC = [ 1 / 1.99 X 16% + 0.99 / 1.99 X 7% (1- 0.30)]

= 0.080 + 0.0248

= 10.48%

V^L = E + D

Which is 287 X 1.99

V^L = 571.13

FCF /  WACC - g = 571.13

8 / 0.1048 - g = 571.13

8 = 59.85 - 571.13g

51.85 = 571.13g

g = 9.07%

Therefore expected growth is 9.07%

PART B)

Before Tax WACC = [ 1 / 1.99 X 16% + 0.99 / 1.99 X 7%]

= 0.080 + 0.034

= 11.4%

V^U = FCF / Before Tax WACC - g

= 8 / (0.114 - 0.0907)

= 8 / 0.0233

= $ 343.3 Million

Interest Tax Shiled = 571.13 - 343.3

= $227.83 Million