Question

Acme Storage has a market capitalization of $111 million, and debt outstanding of $159 million. Acme plans to maintain this same​ debt-equity ratio in the future. The firm pays an interest of 6.7% on its debt and has a corporate tax rate of 35%.

a. If​ Acme's free cash flow is expected to be $10.80 million next year and is expected to grow at a rate of 6% per​ year, what is​ Acme's WACC?

b. What is the value of​ Acme's interest tax​ shield?

Answer 1

a. The WACC is computed as follows:

Market capitalization + debt outstanding = Expected free cash flow next year / (WACC - growth rate)

$ 111 million + $ 159 million = $ 10.80 million / (WACC - 0.06)

$ 270 million = $ 10.80 million / (WACC - 0.06)

(WACC - 0.06) = $ 10.80 million / $ 270 million

WACC = 10%

b. The value is computed as follows:

WACC for computation of value will be as follows:

= WACC as computed above + Debt / (Debt + Equity) x cost of debt x tax rate

= 10% + $ 159 million / ($ 159 million + $ 111 million) x 0.067 x 0.35

= 0.113809444

So, the value will be as follows:

= FCF / (WACC - growth rate)

= $ 10.80 million / (0.113809444 - 0.06)

= $ 200.7082623 million

So, the value of interest tax shield will be as follows:

= $ 159 million + $ 111 million - $ 200.7082623 million

= $ 69.29 million Approximately

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