Please consider the following information for the next 4 questions (Q17 - Q20).

Question

Please consider the following information for the next 4 questions (Q17 - Q20). TAMU Inc. is for sale and there is a price tag of $225,000. Your company, ABC, who is considering the purchase, has a beta of 1.5, the market is expected to have a 20% return and the risk-free rate is 5%. The forecasted free cash flows for the next 4 years for TAMU are 7000 (FCF1), 22000(FCF2), 0(FCF3), and 50000 (FCF4). The company is expected to grow at 4% indefinitely after that. Your company has a debt/equity ratio of 2/3 and the applicable tax rate is 35%. ABC's cost of debt (before taxes) is 8%. What is the cost of equity for ABC company? (Points : 5) 35%
30%
27.5%
22.5%

Question 18. 18. Continuing with the information from Q17, what is ABC's WACC? (Points : 5) 18.58%
19.70%
21.41%
15.88%

Explanation / Answer

TAMU Inc. is for sale and there is a price tag of $225,000. Your company, ABC, who is considering the purchase, has a beta of 1.5, the market is expected to have a 20% return and the risk-free rate is 5%. The forecasted free cash flows for the next 4 years for TAMU are 7000 (FCF1), 22000(FCF2), 0(FCF3), and 50000 (FCF4). The company is expected to grow at 4% indefinitely after that. Your company has a debt/equity ratio of 2/3 and the applicable tax rate is 35%. ABC's cost of debt (before taxes) is 8%.

What is the cost of equity for ABC company?

Working

As per CAPM

Cost of equity =  risk-free rate + (Expected Return on Market -  risk-free rate)*beta

Cost of equity = 5 + (20-5)*1.5

Cost of equity = 27.50%

Answer

27.5%

Question 18. 18. Continuing with the information from Q17, what is ABC's WACC? (Points : 5)

Working

WACC = Weight of Common Stock* Cost of Common Stock + Weight of Debt* After Tax cost of Debt

WACC = 1/(1+2/3) * 27.5 + (2/3)/(1+2/3) * (8*(1-35%))

WACC = 18.58%

Answer

18.58%

Question 19. 19. Continuing with the information from Q17, what is the terminal value for TAMUC Inc. after the 4th year (TV4)? (Points : 5)

Working

Terminal value = FCFF5/(WACC-g)

Terminal value = 50000*(1+4%)/(18.58%-4%)

Terminal value = 356,652.95

Answer

356,652.95

Question 20. 20. Continuing with the information from Q17, what is the NPV of purchasing TAMU Inc.? (Points : 5)

Working

NPV = -Initial Investment + FCFF1/(1+ WACC) + FCFF2/(1+ WACC)^2 + FCFF3/(1+ WACC)^3 + FCFF4/(1+ WACC)^4 + Terminal value/(1+ WACC)^4

NPV =  -225000+ 7000/(1+ 18.58%) + 22000/(1+ 18.58%)^2 + 0/(1+ 18.58%)^3 + 50000/(1+ 18.58%)^4 + 356652.95/(1+ 18.58%)^4

NPV = 2,222.46

Answer

positive 2,220.43 Approx

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