Question

18.2

Acort Industries has 11 million shares outstanding and a current share price of $47 per share. It also has long-term debt outstanding. This debt is risk free, is four years away from maturity, has an annual coupon rate of 7% , and has a $116 million face value. The first of the remaining coupon payments will be due in exactly one year. The riskless interest rates for all maturities are constant at 4.2%. Acort has EBIT of $104 million, which is expected to remain constant each year. New capital expenditures are expected to equal depreciation and equal $10 million per year, while no changes to net working capital are expected in the future. The corporate tax rate is 35% , and Acort is expected to keep its debt-equity ratio constant in the future (by either issuing additional new debt or buying back some debt as time goes on).

a. Based on this information, estimate Acort's WACC.

b. What is Acort's equity cost of capital?

Answer 1

a). E = 11 million × $47 = $517 million.

The market value of Acort’s debt:

D = [($116 million x 7%) x {(1 - 1.042^-4) / 0.042}] + [$116 million / 1.042⁴]

= [$8.12 million x 3.6129] + $98.40 million = $29.34 million + $98.40 million = $127.73 million

Therefore, Acort’s enterprise value:

E + D = $517 million + $127.73 million = $644.73 million

Acort’s FCF = [EBIT x (1 - Cτ)] + Dep - Capex - Inc in NWC

= $104 million x (1 - 0.35) = $67.60 million

Because Acort is not expected to grow,

V^L = FCF / r_wacc

$644.73 million = $67.60 million / r_wacc

r_wacc = $67.60 million / $644.73 million = 0.1048, or 10.48%

b). r_wacc = [wD x rD x (1 - t)] + [wE x rE]

10.48% = [(127.73/644.73) x 4.2% x (1 - 0.35)] + [(517/644.73) x rE]

10.48% = 0.54% + [0.80 x rE]

9.94% = 0.80 x rE

rE = 9.94% / 0.80 = 12.40%