Question

Restex has a? debt-equity ratio of 0.69?, an equity cost of capital of 13%?, and a debt cost of capital of 10%. Restex's corporate tax rate is 38%?, and its market capitalization is $294 million.

a. If? Restex's free cash flow is expected to be $11 million one year from now and will grow at a constant? rate, what expected future growth rate is consistent with? Restex's current market? value?

b. Estimate the value of? Restex's interest tax shield.

Answer 1

(a) Market Capitalization = Equity Value = E = $ 294 million

Debt to Equity Ratio = 0.69 and let debt value be D

Therefore, D/E = 0.69

D = 294 x 0.69 = $ 202.86 million

Cost of Debt = 10 % and Cost of Equity = 13 %, Tax Rate = 38 %

WACC = (1-0.38) x 10 x (0.69/1.69) + 13 x (1/1.69) = 10.224 %

FCFF1 = $ 11 million and let growth rate be g

Firm Value = E + D = 294 + 202.86 = $ 496.86 million

Therefore, 496.86 = FCFF1 / (WACC - g)

496.86 = 11 / (0.10224 - g)

g = 0.08014 or 8.014%

(b) Interest Rate = Cost of Debt = 10 % , Debt = $ 202.86 million and Tax = 38 %

Interest Tax Shield = 0.1 x 202.86 x 0.38 = $ 7.70868 million

PV of Interest Tax Shield = 0.38 x 202.86 = $ 77.0868 million