You have the following initial information on Financeur Co. on which to base your calculations and discussion for questions 1) and 2): Note: I need help with Question 2 ONLY, I have completed question 1. • Current long-term and target debt-equity ratio (D:E) = 1:3 • Corporate tax rate (TC) = 30% • Expected Inflation = 1.55% • Equity beta (E) = 1.6345 • Debt beta (D) = 0.15 • Expected market premium (rM – rF) = 6.00% • Risk-free rate (rF) =2% 1) The CEO of Financeur Co., for which you are CFO, has requested that you evaluate a potential investment in a new project. The proposed project requires an initial outlay of $7.26 billion. Once completed (1 year from initial outlay) it will provide a real net cash flow of $555 million in perpetuity following its completion. It has the same business risk as Financeur Co.’s existing activities and will be funded using the firm’s current target D:E ratio. 2) Assume now a firm that is an existing customer of Financeur Co. is considering a buyout of Financeur Co. to allow them to integrate production activities. The potential acquiring firm’s management has approached an investment bank for advice. The bank believes that the firm can gear Financeur Co. to a higher level, given that its existing management has been highly conservative in its use of debt. It also notes that the customer’s firm has the same cost of debt as that of Financeur Co. Thus, it has suggested use of a target debtequity ratio of 2:3 when undertaking valuation calculations. a) What would the required rate of return for Financeur Co.’s equity become if the proposed gearing structure were adopted following acquisition by the customer? b) Would the above project described in 1) be viable for the new owner of Financeur Co.? Justify your answer (numerically).
You have the following initial information on Financeur Co. on which to base your calculations
and discussion for questions 1) and 2): Note: I need help with Question 2 ONLY, I have completed question 1.
• Current long-term and target debt-equity ratio (D:E) = 1:3
• Corporate tax rate (TC) = 30%
• Expected Inflation = 1.55%
• Equity beta (E) = 1.6345
• Debt beta (D) = 0.15
• Expected market premium (rM – rF) = 6.00%
• Risk-free rate (rF) =2%
1) The CEO of Financeur Co., for which you are CFO, has requested that you evaluate a
potential investment in a new project. The proposed project requires an initial outlay of
$7.26 billion. Once completed (1 year from initial outlay) it will provide a real net cash
flow of $555 million in perpetuity following its completion. It has the same business risk
as Financeur Co.’s existing activities and will be funded using the firm’s current target D:E
ratio.
2) Assume now a firm that is an existing customer of Financeur Co. is considering a buyout
of Financeur Co. to allow them to integrate production activities. The potential acquiring
firm’s management has approached an investment bank for advice. The bank believes
that the firm can gear Financeur Co. to a higher level, given that its existing management
has been highly conservative in its use of debt. It also notes that the customer’s firm has
the same cost of debt as that of Financeur Co. Thus, it has suggested use of a target debtequity ratio of 2:3 when undertaking valuation calculations.
a) What would the required
proposed gearing structure were adopted following acquisition by the customer?
b) Would the above project described in 1) be viable for the new owner of Financeur
Co.? Justify your answer (numerically).
As per the given information:
• Current long-term and target debt-equity ratio (D:E) = 1:3
• Corporate tax rate (TC) = 30%
• Expected Inflation = 1.55%
• Equity beta (E) = 1.6345
• Debt beta (D) = 0.15
• Expected market premium (rM – rF) = 6.00%
• Risk-free rate (rF) =2%
To determine:
- The required rate of return if the proposed gearing structure is adopted.
- The viability of the project.
Step by step
Solved in 3 steps
