Question

In: Finance

4. Tri Co. has the following cost of debt structure (14’) wd 0% 20% 30% 40%...

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?

Solutions

Expert Solution

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

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