Question

You are a MNC looking at buying a company in England. You have determined that the free cash flow is $150 Million growing at 9% each year. How much would you pay for this company? You will have to use the Capital Asset Pricing Model (CAPM), determine the Weighted Average Cost of Capital (WACC) and then discount the free cash flows that you will determine after applying the growth For the MNC:

For England:

•The Tax rate is determined by research.

•The cost of debt is 14%

•Risk free rate determined by research on your country.

When using CAPM the 10 year treasury is preferred

•Market return is determined by research. A good proxy for your country should be the average market return of an index in your country similar to the S&P 500 over the last 20 years.

•The Beta 1.3 •50% debt 50% equity

•Perpetual growth 2.5%

To calculate the cost of equity Rf + B * (MR – Rf), CAPM The WACC= E/V*Ce + D/V *Cd*(1-T)

The value of your company is the sum of all the cash flows plus the terminal value discounted by the WACC.

The Perpetuity Growth approach assumes that free cash flow will continue to grow at a constant rate into perpetuity.

The Terminal Value can be estimated using the formula below.

TV=FCF (final forecast year) * (1 +g) WACC-g PV0= FCF1 +FCF2 +FCF3 +FCF4 +FCF5 +TV (1+WACC)1 (1+WACC)2 (1+WACC)3 (1+WACC)4 (1+WACC)5 (1+WACC)5

Answer 1

For England:

• Risk free rate: 2.1% as determined from https://www.statista.com/statistics/885750/average-risk-free-rate-united-kingdom/
• Corporate tax rate : 19% determined from https://tradingeconomics.com/united-kingdom/corporate-tax-rate
• Assume corporate tax rate to be constant in future
• Market return: Considered the proxy of FTSE 100 returns over last 10 years annualized, determined from https://www.ig.com/uk/trading-strategies/what-are-the-average-returns-of-the-ftse-100--190318; Total return with dividends reinvested = 8.3%

the cost of equity, Ce = Rf + B * (MR – Rf) = 2.1% + 1.3 x (8.3% - 2.1%) = 10.16%

The cost of debt, Cd = 14%

The WACC= E/V*Ce + D/V *Cd*(1-T) = 50% x 10.16% + 50% x 14% x (1 - 19%) = 10.75%

All financials below are in $ million.

FCF1 = 150; FCF2 = 150 x (1 + 9%) = 157.50 ; FCF3 = 157.50 x (1 + 9%) = 165.38; FCF4 = 173.64 and similarly FCF5 = 182.33

g = 2.5%

TV=FCF (final forecast year) * (1 +g) / (WACC - g) = 182.33 x (1 + 2.5%) / (10.75% - 2.5%) =  2,265.26

Hence, The value of your company is the sum of all the cash flows plus the terminal value discounted by the WACC =

FCF1 / (1+WACC)¹ +FCF2 / (1+WACC)² + FCF3 / (1+WACC)³ + FCF4 / (1+WACC)⁴ +FCF5 / (1+WACC)⁵ +TV / (1+WACC)⁵ =   150.00 / (1 + 10.75%) + 157.50 / (1 + 10.75%)² + 165.38 / (1 + 10.75%)³ + 173.64 / (1 + 10.75%)⁴ +182.33 / (1 + 10.75%)⁵ +  2,265.26 / (1 + 10.75%)⁵ = 135.44 + 128.41 + 121.74 + 115.42 + 109.43 + 1,359.56 = 1,970.00      

Hence,t he value of the company = $ 1,970.00 million