Question

Seahawk Incorporated is expected to have an EBIT of $2.2 million next year. Depreciation, the increase in net working capital, and capital spending are expected to be $165,000, $85,000, and $115,000 respectively. All are expected to grow at 17% per year for four years. The company currently has $12.5 million in debt and 800,000 shares outstanding. After year 5, the adjusted cash flow from assets is expected to grow at 3% annually indefinitely. The debt includes bonds with a face value of $1,000 each, 22 years left to maturity, a coupon of 6.5%, paid semiannually, currently valued at 104 of par. Seahawk pays 30% corporate taxes. Its beta is 1.1. Assume Government of Canada 25 year bonds have an interest rate of 3% and the return on the overall stock market is 8%. Assume the debt to equity ratio is 0.8.

What is the WACC and what is the price per share of the company's stock?

Answer 1

	Let's find the WACC first:
	1. Cost of Equity by CAPM:
	Risk free rate =Rf=3%
	Market return =Rm=8%
	beta=1.1
	Cost of Equity =k=Rf+beta*(Rm-Rf)
	k=3%+1.1*(8%-3%)
	K=8.5% . So cost of Equity =8.5%
	2. Cost of Debt:
	Par value	1,000
	Market price @104%=	1,040
	Years to maturity	22
	Semi annual coupon @6.5%pa=	32.500
	No of coupon payments due =	44
	Finding Cost of debt or YTM from
	excel function =RATE
	YTM =	6.165%

=Rate(nper =44, pymt =coupon32.5, pv= market price =-1040, fv=par 1000, type=0)*2 as annualization factor

Pre Tax cost of debt =6.165%
Tax rate =30%
After Tax cost of debt =6.165%*(1-30%)=	4.316%

WACC =0.8/1.8*4.316%+1/1.8*8.5%
WACC =6.64%
So we shall use 6.64% as discount factor for cash flows:

	Free cash flow calculation	Year 1	Year 2	Year 3	Year 4	Year 5
	EBIT with 17% growth	2,200,000	2,574,000	3,011,580	3,523,549	4,122,552
a	EBIT *(1-Tax) when Tax =30%=	1,540,000	1,801,800	2,108,106	2,466,484	2,885,786
b	Add : Depreciation With 17% increase	165,000	193,050	225,869	264,266	309,191
c	Less: Increase in NWC with 17% increase=	85,000	99,450	116,357	136,137	159,280
d	Less : Capital spending with 17% increase=	115,000	134,550	157,424	184,185	215,497
e	Free Cash flow =a+b-c-d=	1,505,000	1,760,850	2,060,195	2,410,428	2,820,200
f	Terminal Cash flow T yr 5 end with growth rate g=3% and WACC =6.64%=2820200*1.03/(6.64%-3%)=					79,802,369.74
g	Total FCF +Terminal Cash flow	1,505,000	1,760,850	2,060,195	2,410,428	82,622,570
h	PV factor @6.64%=1/1.0664^n	0.9377	0.8793	0.8246	0.7732	0.7251
i	PV of FCF+terminal cah flow=g*h=	1,411,290	1,548,396	1,698,822	1,863,861	59,909,820

j	Enterprise value=Sum of PV of FCF & terminal cash flow	$     66,432,189.73
k	Less Debt $12.5Million with 104 of Par market value =$12.5M*1.04=	(13,000,000)
l	Market value of Equity =	$     53,432,189.73
m	No of shares outstanding	800,000
n	Price per share =l/m=	$                     66.79