Question

1. Alliant Technology is a publicly traded company that sells both computer hardware and services. It has no debt outstanding or cash. In the most recent year, the company reported the following information about its two businesses: Sector Averages Business Revenues (in $ millions) Enterprise Value/Sales Unlevered Beta Computer hardware $1,000 0.80 1.25 Computer services $600 2.00 0.9 The company also provides the breakdown of revenues geographically: Country Risk free rate In local currency Equity Risk Premium Marginal tax rate Total Revenues (in $ millions) United States 3.00% (US $) 5.00% 40% $800.00 China 4.00% (Yuan) 7.00% 25% $800.00 Both countries have the same mix of hardware & service businesses.

a. Estimate the cost of equity in US dollars for Alliant Technology (2 points)

b. Now assume that Alliant wants to sell just its hardware business in the United States at fair value (based on the EV/Sales ratio for the sector) in the United States, borrow an additional $400 million in the US and invest the total amount in computer services in China. Estimate the cost of equity in US $ for Alliant after the transaction. (3 points)

Answer 1

Answer to Part (a)

Computation of Estimated Cost of Equity of Alliant Technology.

The Cost of Equity can be computed by using CAPM model which is as below:

Cost of Equity = Risk Free Rate + (Risk Premium * beta)

The following figure is given in the question itself

Risk Free rate of USA: 3%

Risk Premium : 5%

Now, beta we have to calculate:

It is mentioned in the question that both countries have the same mix of computer hardware and services, hence the beta is =1.25*0.50+0.90*0.50=1.075

Now, we have all the requisite data to claculate the Cost of Equity

So, Cost of Equity is = 3%+(5*1.075)= 8.375%

Cost of Equity in value: $1000*8.375%=83.75%

Answer of Part b

Hard ware business in USA is of 500.00$

Remains Services business $300.00

Enterprise Value = 300*2 = $ 600.00

cost of equity in $ is 600*8.375% i.e. $50.25