Restex has a debt-equity ratio of 0.76, an equity cost of capital of 18 %, and a debt cost of capital of 9 %.

Restex's corporate tax rate is 30%, and its market capitalization is $ 199 million.

a. If? Restex's free cash flow is expected to be $5 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.

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Expert Solution

(a) Market Capitalization = $ 199 million, Debt to Equity Ratio = 0.76

Debt Value = 0.76 x 199 = $ 151.24 million

Firm Value = Debt + Equity = 151.24 + 190 = $ 350.24 million

Free Cash Flow (to Firm) = FCFF1 = $ 5 million

Let the constant growth rate be g

Cost of Equity =18 %, Cost of Debt = 9 % and Tax Rate = 30 %

Debt Proportion = 0.76 / 1.76 = 0.432 approximately.

Equity Proportion = 1 / 1.76 = 0.568 approximately.

WACC = 0.432 x 9 x (1-0.3) + 0.568 x 18 = 12.9456 %

Therefore, 350.24 = 5 / (0.129456 - g)

g = 0.1152 or 11.52 % approximately.

(b) Debt Value = $ 151.24 million, Cost of Debt = 9 % and Tax Rate = 30 %

Interest Tax Shield = 0.3 x 0.09 x 151.24 = $ 4.08348 million

PV(present value) of Interest Tax Shield (assuming constant debt) = 4.08348 / 0.09 = $ 45.372 million

PV(present value) of Interest Tax Shield (assuming constant debt proportion) = 4.08348 / 0.129456 = $ 31.54 million

jeff jeffy answered 1 year ago

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