Question

Question:

Riverroad Chicken Company , a company selling roasted chicken and other accompaniments in outlets throughout the country , went public last year , 2011.In 2010 , it had revenues of Sh.40 million,on which reported earnings before interest and taxes of Sh.12 million.At that time, prior to going public, the firm had no debt outstanding, and expected revenues are to grow at 35% a year from 2011 to 2015, 15% a year from 2015 to 2017 and 5% a year after that.The pre-tax operating margins (EBIT/Revenues) were expected to remain stable.

Capital expenditure which exceeded depreciation by Sh.5 million in the year prior to going public were expected to grow 20% a year from 2011 to 2015, as is depreciation .After 2016, capital expenditure are expected to offsetdepreciation.Working Capital are negligible.

The average beta of publicly traded fast food chains with which Riverroad Chicken will be competing is 1.15 and their average debt-equity ratio is 25%.The company in question plans to move to the industry average debt ration after that (2015).The pretax cost of debt is expected to be 8% .The treasury bond rate is 7% .Assume a 40% tax regime, and an average stock in the market earn a return of 12.50%

Required>

Estimate the cost of equity for the company,Riverroad Chicken Ltd and the Value of its equity.

Answer 1

All Figures in Millions
Important Event		Gone Public					Debt Equity Ratio of 25 %
Year ->	2010	2011	2012	2013	2014	2015	2016	2017	2018	2019	2020
Revenue	40.00	54.00	72.90	98.42	132.86	152.79	175.71	202.06	212.17	222.78	233.91
Percentage Increase in Revenue		35%	35%	35%	35%	15%	15%	15%	5%	5%	5%
EBIT
Debt	0	0
Capital Expenditure	6	7.2	8.64	10.368	12.4416	14.92992
Depreciation	1	1.2	1.44	1.728	2.0736	2.48832
Capital Expenditure - Depreciation	5	6	7.2	8.64	10.368	12.4416
Working Capital	0	0	0	0	0	0	0	0	0	0	0
Industry Beta	1.15
Debt Equity Ratio	25%
Pretax Cost of Debt	8%
Treasury Bond Rate	7%
Tax Rate	40%
Industry ROE	12.50%
Cost of Equity =	Risk-Free Rate of Return + Beta * (Market Rate of Return - Risk-Free Rate of Return)
	7%	+	1.15	x	(12.5%	-	7%)
	0.07	+	1.15*(.125-.07)
	0.13325
	13.325%
Let us assume that no reserve is maintained
Let the Equity Capital	X		Cost of Equity	13.33%
Therefore Debt	25%X		Cost of Debt	8%
Revenue 2016	175.71
Interest on Debt	.25X*.08
EBT	175.71-.25X*.08
Tax	(175.71-.25X*.08)*.4
Earning After Interest & Tax		175.71-.25X*.08-(175.71-.25X*.08)*.4			(EBT - Tax)
Dividend Paid	0.13325*X
Earning After Interest & Tax		=	Dividend Paid
	0.13325*X	=	175.71-.25X*.08-(175.71-.25X*.08)*.4
	0.13325X	=	175.71 - 0.02X - 70.284 + 0.032X
			105.426+0.012X
	X	=	105.426/0.12125
			869.4928
Value of its Equity	869.4928
Answer	Cost of Equity		13.325%
	Value of its Equity		869.4928