Question

You are a manager in a start-up firm based in Bengaluru. The firm is planning to go public and you havebeen tasked at arriving at an approximate valuation for the firm. The firmisin the business of providing medical grade pure water. The asset beta of the firms’ in the industry with similar size is 1.3 and 1.4. The risk free rate is 5% and the market risk premium is 7%. At present, the firm doesn’t have any debt, however the management intendstotargetadebtequityratioof 1. The cost of debt for similar firms with similar capital structure is 8.5%. What is the WACCof the firm given the intended capital structure ? What should be the value of the firm ifthe Free cash flow to the firm you have arrived at isINR 12 million and is expected to grow at a rate of 2% in perpetuity.

Answer 1

average of beta for the similar firm	(1.3+1.4)/2	1.35
risk free rate		5%
market risk premium		7%
required rate of return on equity =risk free rate+(market risk premium)*beta	5+(7)*1.35	14.45
WACC =(weight of debt*cost of debt)+(weight of equity*required rate of return)	(.5*8.5%)+(.5*14.45%)	11.48%
value of firm =expected cash flow/(WACC-growth rate)	12.24/(11.48%-2%)	129.11
expected free cash flow	cash flow*(1+growth rate)	12*(1.02)	12.24
WACC			11.48%
growth rate			2%