Question

XYZ Corp estimates the following FCFs and interest expenses for 2019, 2020 and 2021. After 2020...

  1. XYZ Corp estimates the following FCFs and interest expenses for 2019, 2020 and 2021. After 2020 the firm expects that both FCFs and interest expenses will be growing at a constant 5 percent rate indefinitely. XYZ’s unlevered cost of equity is 13%. Federal plus state tax rates are 25%. (14 points)

2019

2020

2021

FCF (millions)

$35

$50

$70

Interest expense (millions)

$4

$6

$8

  1. What is the firm’s unlevered horizon value in 2021?
  2. What is the firm’s current unlevered value?
  3. What is the horizon value of the tax shield in 2021?
  4. What is the current value of the tax shield?
  5. What is the current total value of the company?

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Homework Answers

Answer #1

a. Firm's Unlevered Horizon Value = (FCF in 2021 * (1 + Growth Rate)) / (Cost of Equity - Growth Rate)

Firm's Unlevered Horizon Value = (70 * (1 + 0.05)) / (13% - 5%)

Firm's Unlevered Horizon Value = $918.75 Millions

b. Firm's Current Unlevered Value = 35 / 1.13 + 50 / 1.13^2 + 70 /1.13^3 + 918.75 / 1.13^3

Firm's Current Unlevered Value = $755.38 Millions

c. Horizon value of Tax Shield = ((Interest Expense in 2021 * Tax Rate) * (1 + Growth Rate)) / (Cost of Equity - Growth Rate)

Horizon value of Tax Shield = (($8 * 0.25) * (1 + 0.05)) / (13% - 5%)

Horizon value of Tax Shield = $26.25 Million

d. The current value of the tax shield = 4 * 0.25 / 1.13 + 6 * 0.25 / 1.13^2 + $8 * 0.25 /1.13^3 + 26.25/1.13^3

The current value of the tax shield = $21.64 Million

e. the current total value of the company = $21.64 Million + $755.38 Million

the current total value of the company = $777.02 Million

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