ABC Ltd, a construction company, earned $5 million in after-tax operating income in the most recent year. The firm also had fixed cost investment (ie cash involvement related to the capital expenditure for the year) of $4 million and depreciation of $2 million during the year. Working capital at the end of the year was $10 million. The firm also had $15 million in outstanding debt and a pretax cost of debt of 8%. There were 10 million shares outstanding trading at $2 per share, and the most recent beta is 1.10. The tax rate for the firm is 40%, the treasury bond rate is 7% and return on the market is 12.5%. a) Estimate the firm’s weighed average cost of capital (WACC). b) Assuming that the firm’s operating income will grow 10 percent for the next three years, and that the fixed cost investment, depreciation, and working capital will grow at the same rate, estimate the FCFF and its present value for each year over this period. c) Assuming that after the next three years the firm will reach a stable-growth period and the outstanding debt will reduce to $7.5 million with no change in cost of debt, estimate the firm’s new beta and the WACC during this stable-growth stage. d) Assuming that in this stable-growth period the growth rate indicated in part (b) will drop to 4%, estimate the terminal value of the FCFF. e) Estimate the current total value of the firm. f) Estimate the current value of equity of the firm. g) Estimate the value per share of the firm. h) Suggest whether to buy, hold or sell the stock
Please help me with this question :) A detailed answer will be much appreciated.
ABC Ltd, a construction company, earned $5 million in after-tax operating income in the most recent year. The firm also had fixed cost investment (ie cash involvement related to the capital expenditure for the year) of $4 million and
- a) Estimate the firm’s weighed average cost of capital (WACC).
- b) Assuming that the firm’s operating income will grow 10 percent for the next three years, and that the fixed cost investment, depreciation, and working capital will grow at the same rate, estimate the FCFF and its present value for each year over this period.
- c) Assuming that after the next three years the firm will reach a stable-growth period and the outstanding debt will reduce to $7.5 million with no change in cost of debt, estimate the firm’s new beta and the WACC during this stable-growth stage.
- d) Assuming that in this stable-growth period the growth rate indicated in part (b) will drop to 4%, estimate the terminal value of the FCFF.
- e) Estimate the current total value of the firm.
- f) Estimate the current value of equity of the firm.
- g) Estimate the value per share of the firm.
- h) Suggest whether to buy, hold or sell the stock.
"Since you have posted a question with multiple sub-parts, we have solved the first three for you. To get it solved completely, please repost it with the mentioned sub-parts left which needs to be solved".
The weighted average cost of capital(WACC) is considered as the cut-off rate or the minimum rate of return in assessing the profitability of the capital structure so formed so as to generate an adequate return to satisfy the expectations of the investors. The formula for calculating the weighted average cost of capital is as follows:
Part a. Calculation of the firm’s weighted average cost of capital (WACC):
|
Source of Funds |
Proportion |
Cost of Capital(a) |
Weights(b) |
WACC(a*b) |
|
Equity |
20,000,000 |
13.05% |
4/7 |
7.457% |
|
Debt |
15,000,000 |
4.8% |
3/7 |
2.057% |
|
Total |
35,000,000 |
|
7 |
9.514% |
Step by step
Solved in 4 steps with 1 images
