Question

Tybo Corporation adjusts its debt so that its interest expenses are 20% of its free cash flow. Tybo is considering an expansion that will generate free cash flows of $2.52 million this year and is expected to grow at a rate of 4.4% per year from then on. Suppose? Tybo's marginal corporate tax rate is 38%.

a. If the unlevered cost of capital for this expansion is 9.3%?, what is its unlevered? value?

b. What is the levered value of the? expansion?

c. If Tybo pays 5.7% interest on its? debt, what amount of debt will it take on initially for the? expansion?

d. What is the? debt-to-value ratio for this? expansion? What is its? WACC?

e. What is the levered value of the expansion using the WACC? method?

Answer 1

Tax rate , t = 38% = 0.38

interest expense, i = 20% = 0.20

FCF = $2.52 million

growth rate, g = 4.4% = 0.044

a)

cost of capital , r = 9.3% = 0.093

Value unlevered, u = FCF/(r-g) = 2.52/(0.093-0.044) = $51.42857143 million or $51.43 million

b)

Value of levered , l = (1+t*i)*u = (1+0.38*0.20)*51.42857143 = 1.076*51.42857143 = $55.33714286 million or $55.34 million

c)

let the value of debt = D

Interest = 20%*FCF = 0.20*2.52 = 0.504 million = interest*D

0.504 = 5.7%*D = 0.057*D

D = 0.504/0.057 = $8.842105263 million or $8.84 million

d)

Debt to value ratio, d = D/l = 8.842105263/55.33714286 = 0.159786082 or 15.9786082% or 15.98%

WACC = r - (t*d*interest) = 0.093-(0.38*0.159786082*0.057) = 0.093-0.003460967 = 0.089539033 or 8.9539033% or 8.95%

e)

value of levered = FCF/(WACC-g) = 2.52/(0.089539033   - 0.044) = $55.33714 million or $55.34 million