Question

Boogle is back and has no debt! Boogle has an equity Beta of 1.6, with market expected return of 10% and a risk free rate of 3%. Boogle’s cash flows are expected to be 80 million next year and will grow at 3% per year. Boogle has 4 million shares outstanding. If Boogle wants to add debt and maintain an interest coverage ratio of 10%, where corporate taxes are 40% and the cost of debt capital will be 5%.

What will be Boogle’s value if you add leverage and maintain an interest coverage ratio of 10%?

Answer 1

Cost of capital(r) = Rf + * (Rm-Rf)

= 3% + 1.6 ( 10% - 3%) = 14.2%

Therefore Value of firm today = FCFF1/ (r-g)

= 80M / (14.2 - 3%)

= 975.61 Milllion

Therefore stock price = 975.61 / 4 = 243.90 per share (4 = no of outstanding shares in million)

Interest coverage ratio = EBIT/Interest expense

Interest expense = EBIT/ Interest coverage ratio

= OCF/(I-Tax)/IC ratio

= 80/(1-0.4)/10

= 13.33 Million

With 5% interest rate, total value of debt = 13.33/5 = 266.67 million

What will happen to boogle's Value?

Total value of boogle will remain same as before = 975.61 million, but neverthless total value of equity will reduce by amount of debt.

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