In: Finance
4. Tri Co. has the following cost of debt structure (14’) wd 0% 20% 30% 40% 50% rd 0.0% 9.0% 10.0% 11.0% 12.0% The market risk premium is 4.5%, the risk free rate is 5%, beta of unleveraged firm is 1.20, Hamada’s equation b= bU [1 + (1 - T)(wd/we)]. T=40%. Please use the above information to answer following questions:
a) If the firm uses 50% debt, what is the cost of equity of the firm, based on CAPM model?
b) What is WACC of the firm?
c) If the firm has infinite FCF1=35 million and grow at 5% forever, what is the firm’s value?
a)
Unlevered Beta (bU) | 1.2 |
T | 40 |
wd/we | 50 |
Using Hamada's equation to find levered Beta | |
b= | bU [ 1+ (1-T)(wd/we)] |
b= | 1.20[1+((1-0.4)*(0.5))] |
b= | 1.56 |
Cost of Equity = | Risk Free Rate + Beta x (Market Risk Premium) |
= | 0.05 + 1.56 ( 0.045) |
= | 0.1202 |
= | 12.02% |
b)
WACC= | E/V*Cost of Equity +D/V* Cost of Debt |
= | (0.5 *0.1202) + (0.5 * 0.12*(1-0.4)) |
= | 0.0961 |
= | 9.61% |
c)
Firm' Value= | FCF/WACC-Growth rate |
= | 1.35/(0.0961-0.05) |
= | 29.28 million |