Private equity investors are planning to provide financing to Jones Machinery an

Question

Private equity investors are planning to provide financing to Jones Machinery and has approached your firm to perform a valuation assessment of Jones. Jones Machinery has 3 million shares outstanding and a target capital structure consisting of 30 percent debt. The debt interest rate is 8 percent. Assume that the risk-free rate of interest is 3 percent and the return on the market is 9 percent. Jones' historical free cash flow has averaged $4 million per year and is expected to grow at a constant rate of 5 percent a year; its beta is 1.2. Jones has $6 million in debt. The tax rate of Jones Machinery is 18 percent. a. Calculate the required rate of return on equity using CAPM for Jones b. Calculate weighted average cost of capital of Jones c. Calculate the value of operations of Jones d. Calculate the value of the Jones' equity

Explanation / Answer

1. Required rate of return = Risk free rate + beta*(Market rate - Risk free rate) = 3 + 1.2*(9-3) = 10.2 %

2. Weighted average cost of capital of Jones = Debt*cost of Debt*(1- tax rate) + Equity* cost of Equity

= 0.3*0.08*(1-0.18) + 0.7*0.102

= 0.09108 = 9.108 %

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