The following information has been presented to you about the Gibson Corporation
ID: 2727277 • Letter: T
Question
The following information has been presented to you about the Gibson Corporation S3,000 millionTax rate Total assets Operating income (EBIT) Interest expense Net income Share price $800 million Debt ratio $0 millionwACC S480 millionM/B ratio 40% 0% 10% 1.00× $3.20 $32.00EPS DPS The company has no growth opportunities (g -0), so the company pays out all of its earnings as dividends (EPS DPS). The consultant believes that if the company moves to a capital structure financed with 20% debt and 80% equity (based on market values) that the cost of equity will increase to 11% and that the pre-tax cost of debt will be 10%. If the company makes this change, what would be the total market value (in millions) of the firm? a. $4,800 b. $3,200 c. $3,600 d. $4,200 e. $4,000 O a. Ob. O c.Explanation / Answer
Answer to Q1 :
WACC = Weight * Cost of Equity + Weight of Debenture (1 – Tax)rate of debenture =
WACC = (0.8(0.11)) + (0.2(1 – 0.4)0.10) = 0.10
FCF (Free Cash flow)= NOPAT – Investment in capital = EBIT(1 – T) -0 (As, Investment in capital is zero)
FCF = 800 (1- 0.40) = 480 Million
Value of the Firm = FCF/ (WACC - g)
Value of the firm = 480/ (0.10-0)= 4800 million
Answer 2.
V = FCF/WACC = NOPAT/WACC = EBIT (1-t)/WACC
= $20(1-0.40)/0.1 = $120 Millions
S = wcV = 0.6($120) = $72 Million.
D = wdV = 0.4($120) = $48 Million
P = [S + (D – D0)]/n0 = [$72 + ($48 – 0)]/2.5 = $48.
Answer 3.
Beta = 1.10
Target % of debt = 30%
Target Debt/ Equity ratio = 0.43
Tax rate = 40%
bl = bu * (1 + D/E) * (1-T) = 1.3
r(rf) = 5%
r (pm)= 6%
r(su) = r(RF)+ b(U) (RPm) = 11.60%
rsL= rRF+ bL(RPM) =13.30%
Change in equity cost =1.70%
Answer 4.
Current market value - 10,000 shs @ 60 = 600,000
WACC -
Debt 200,000 x 3.6% (6% - 40%) = 7,200
Equity 600,000 x 8.8% = 52,800
Total Cost 60,000
Total Capital 800,000
WACC - 60,000 / 800,000 = 7.5%
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