Question

Zoom Enterprises has FCFF of 700 million Swiss francs (CHF) and FCFE of CHF620 million. Zoom’s before-tax cost of debt is 5.7 percent, and its required rate of return for equity is 11.8 percent. The company expects a target capital structure consisting of 20 percent debt financing and 80 percent equity financing. The tax rate is 33.33 percent, and FCFF is expected to grow forever at 5.0 percent. Zoom Enterprises has debt outstanding with a market value of CHF2.2 billion and has 200 million outstanding common shares.

1. What is zoom’s weighted average cost of capital?

2. What is the value of Zoom’s equity using the FCFF valuation approach?

3. What is the value per share using this FCFF approach?

Answer 1

zoom’s weighted average cost of capital = We*Ke +Wd*Kd*(1-t)

where We= Weight of Equity

Wd = Weight of Debt

Ke= Cost of Equity

Kd= Cost of Debt

t = tax rate

Therefore, zoom’s weighted average cost of capital = 0.8*11.8 +0.2*5.7*(1-0.3333)

= 9.44 + 0.76 = 10.20 %

growth rate till perpetuity (g) for FCFF = 5% =0.05

value of Zoom’s equity using the FCFF valuation approach = FCFF/growth rate

= CHF (700/0.05) = CHF 14,000 million

value per share using this FCFF approach = FCFF calculated above divided by total shares

= CHF(14,000/200) = CHF 70