Ham Co. is thinking to raise $100,000,000 in new equity for a new project. In or
ID: 2642631 • Letter: H
Question
Ham Co. is thinking to raise $100,000,000 in new equity for a new project. In order to preserve the ownership percentages of current stock holders, the management is thinking to raise the new equity through a right issue. At the moment (that is before the right issue) there are 80,000,000 outstanding shares and the market price of each share of stock is 9.5$. The subscription price of the new shares of stock will be $7.7 for each new share. The new project is expected to produce a net income of $18,000,000 in the first year, and to have a constant EBITDA for the 8 years of its life. The new assets will be depreciated by 1/10 of their initial value every year. At the end of its life (that is, after 8 years) the project's assets will be sold at their residual value. The company currently (that is, before starting the new project) holds a $300,000,000 in debt. For the new project, the company plans to keep the same debt-to-equity ratio as the rest of the company and to keep it constant for the life of the project. The unlevered return on equity is 9% while the required return on debt is 3%,the corporate tax rate is 26% and the depreciation tax shield is as risky as the company's debt.
What is the unlevered after tax cash flow from assets at the end of every year?
Explanation / Answer
Current debt equity ratio = Debt/Equity = 300,000,000/(80,000,000*10) = 0.375
Assuming the par value of stock = $10.
The company is proposing to issue new shares for $100,000,000 so the corresponding debt would be $100,000,000*0.375 = $37,500,000.
Interest on new debt = $37,500,000*3% = $1,125,000
Given depreciation tax shield is as risky as the company's debt meaning tax shield on interest = $1.125,000 * 26% = $292,500
Depreciation tax shield =$292,500, it means depreciation is same as interest cost. Since depreciation before tax would be $292500/26% =$1,125,000
Since depreciation =$1,125,000, as the assets would be depreciated by 1/10 th of their value, Value of assets =$1,125,000*10 = $11,250,000
Residual value of the asset at the end of eight years= $11,250,000-$1,125,000*8( as the assets are depreciated over eight years) = $2,250,000
Unlevered free cash flows = EBITDA - Capital expenditure-working capital-taxes.
As we do not have details of working capital it is ignored while calclation of unlevered afterr tax cash flows from assets:
Computation of unlevered free cash flows from assets for the new project for eight years:
Particulars 1 2 3 4 5 6 7 8 Net income after tax $ 18,000,000.00 $ 18,000,000.00 $ 18,000,000.00 $ 18,000,000.00 $ 18,000,000.00 $ 18,000,000.00 $ 18,000,000.00 $ 18,000,000.00 Add: Tax (26%) 6324324.324 6324324.324 6324324.324 6324324.324 6324324.324 6324324.324 6324324.324 6324324.324 Earnings before tax $ 24,324,324.32 $ 24,324,324.32 $ 24,324,324.32 $ 24,324,324.32 $ 24,324,324.32 $ 24,324,324.32 $ 24,324,324.32 $ 24,324,324.32 Add: Interest (3%) $ 1,125,000.00 $ 1,125,000.00 $ 1,125,000.00 $ 1,125,000.00 $ 1,125,000.00 $ 1,125,000.00 $ 1,125,000.00 $ 1,125,000.00 Earning before interest and tax $ 25,449,324.32 $ 25,449,324.32 $ 25,449,324.32 $ 25,449,324.32 $ 25,449,324.32 $ 25,449,324.32 $ 25,449,324.32 $ 25,449,324.32 Add Depreciation $ 1,125,000.00 $ 1,125,000.00 $ 1,125,000.00 $ 1,125,000.00 $ 1,125,000.00 $ 1,125,000.00 $ 1,125,000.00 $ 1,125,000.00 Earning before interest, tax and depreciation $ 26,574,324.32 $ 26,574,324.32 $ 26,574,324.32 $ 26,574,324.32 $ 26,574,324.32 $ 26,574,324.32 $ 26,574,324.32 $ 26,574,324.32 Minus: capital expenditure $ 11,250,000.00 $ - $ - $ - $ - $ - $ - $ - Minus Taxes $ 6,324,324.32 $ 6,324,324.32 $ 6,324,324.32 $ 6,324,324.32 $ 6,324,324.32 $ 6,324,324.32 $ 6,324,324.32 $ 6,324,324.32 Unlevered free cash flows $ 9,000,000.00 $ 20,250,000.00 $ 20,250,000.00 $ 20,250,000.00 $ 20,250,000.00 $ 20,250,000.00 $ 20,250,000.00 $ 20,250,000.00 Add: cash flows from sale of assets $ 2,250,000.00 Unlevered free cash flows in year 8 $ 22,500,000.00Related Questions
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