Question

Acme Storage has a market capitalization of 92 million, and debt outstanding of 43 million. Acme plans to maintain this same debt-equity ratio in the future. The firm pays an interest of 7.8% on its debt and has a corporate tax rate of 30%.

a. If Acme's free cash flow is expected to be $12.15 million next year and is expected to grow at a rate of 2% per year, what is Acme's WACC?
b. What is the value of Acme's interest tax shield?
Click the icon to see the Worked Solution (Formula Solution).
a. If Acme's free cash flow is expected to be $12.15 million next year and is expected to grow at a rate of 2% per year, what is Acme's WACC?
The WACC is %_________. (Round to the nearest integer.)
b. What is the value of Acme's interest tax shield?
The value of Acme's interest tax shield is__________ $ million. (Round to two decimal places.)

Answer 1

a           
Value of Firm = Market capitalisation of Equity+Debt value          
$92 million + $43 million          
135   million      
          
Free cash flow next year=   $12.15   million  
Growth rate =   2%      
          
Value of firm = Free cash flow/(Wacc - growth rate)          
135 m = 12.15 m/(wacc - 2%)          
wacc-2% = 12.15/135          
wacc=   0.0900   .+2%  
0.11   or 11%      
          
So wacc is 11%          
          
b.          
Value of ínterest tax shield = Debt value*Tax rate          
$43 million*30%          
12.9   $ million      
          
So value of interest tax shield is   $12.9 million