Question

Black Hills Co. expects a free cash flow of $8,000,000 next year that will grow at 5% forever. The company currently has no debt and no preferred stock, and its WACC is 10%. The company plans to take some debt of $64,000,000 to repurchase share, but only make interest payments. Black Hills Co. faces a 40% federal-plus-state tax rate, and there are 400,000 shares of stock outstanding.

a. What is the market value of the unlevered firm? (4 Points)

b. What is the share price of unlevered firm? (4 Points)

c. What is the interest tax shield? (4 Points)

d. What is the levered firm value? (4 Points)

e. What is the share price when the firm announces their share repurchase plan? (4 Points)

f. Show the levered firm’s balance sheet. (4 Points)

g. How many shares can the firm repurchase? (4 Points)

Answer 1

a)

value of unlevered firm= expected free cash flow/wacc- growth rate

=8000000/(0.1-0.05)

$                               160,000,000

b) share price = firm value / no of shares

=160,000,000/400,000

=400

c)interest tax shield = debt*tax rate

=64,000,000*40%

=25,600,000

d)value of levered firm = value of unlevered firm + interest tax shield

=160,000,000+25,600,000

=185,600,000

e) 400 ( alreay calculated in b )

f)equity value = valule of firm- debt

=185,600,000-64000000

$        121,600,000

g) no of share purchased = 64000000/400

                    160,000