Question

Acort Industries has

11

million shares outstanding and a current share price of

$45

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

10%​,

and has a

$120

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

6%.

Acort has EBIT of

$106

​million, which is expected to remain constant each year. New capital expenditures are expected to equal depreciation and equal

$12

million per​ year, while no changes to net working capital are expected in the future. The corporate tax rate is

40%​,

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

Answer (a) :

Market value of Equity

Market value of Equity = Shares outstanding * Market price = 11000000* $45 = $495,000,000

Market value of debt:

Face value = $120,000,000

NPER = 4

Annual coupon = 120000000* 10% = $12,000,000

Riskless interest rate = 6%

Market value of debt = PV(rate, nper, pmt, fv, type) = PV(6%,4, -12000000, -120000000,0) = $136,632,506.94

Total market value:

Total market value of Acort firm (V) = Equity Value (E) + Debt Value (D)

= 495,000,000 + 136,632,506.94

= $631,632,506.94

Free Cash Flow (FCF) of Acort:

FCF = EBIT * (1- Tax rate) + Depreciation - Change in Net working capital - Capital expenditure

= 106000000 * (1 - 40%) + 12000000 - 12000000

= $63,600,000

WACC:

Acort's EBIT is expected to remain constant each year

Firm Value = FCF/WACC

=> WACC = FCF / Firm Value = 63,600,000/ 631,632,506.94 = 10.07%

WACC = 10.07%

Answer (b):

WACC = Weight of Equity∗ Re + Weight of debt * Rd * (1- Tax rate)

=>10.07% = 495000000/ 631632506.94 * Re +136632506.94/ 631632506.94 * 6% * (1 - 40%)

=> 10.07% = 0.78368354 * Re + 0.00778739

=> 0.78368354 * Re = 10.07% - 0.00778739 =0.09291261

=> Re = 0.09291261/0.78368354

=> Re = 11.86%

Acort's equity cost of​ capital = 11.86%