The common stock of Buildwell Conservation & Construction, Inc., has a beta of .
ID: 2727545 • Letter: T
Question
The common stock of Buildwell Conservation & Construction, Inc., has a beta of .80. The Treasury bill rate is 6%, and the market risk premium is estimated at 10%. BCCI’s capital structure is 20% debt, paying a 4% interest rate, and 80% equity. Buildwell pays tax at 30%. You need to estimate the value of Buildwell Conservation. You have the following forecasts (in millions of dollars) of Buildwell’s profits and of its future investments in new plant and working capital:
1 2 3 4 Earnings before interest, taxes, depreciation, and amortization (EBITDA) 255 275 290 295 Depreciation 45 55 60 65 Pretax profit 210 220 230 230 Investment 40 43 46 48
From year 5 onward, EBITDA, depreciation, and investment are expected to remain unchanged at year-4 levels. Estimate the company’s total value and the separate values of its debt and equity. (Do not round intermediate calculations. Enter your answers in millions rounded to 1 decimal place.) Total value $ million Debt value $ million Equity value $ million
Explanation / Answer
(in millions)
Year
1
2
3
4
EBITDA
$ 255
$ 275
$ 290
$ 295
Depreciation
$ 45
$ 55
$ 60
$ 65
Profit before tax
$ 210
$ 220
$ 230
$ 230
Tax at 30%
$ 63
$ 66
$ 69
$ 69
Profit after tax
$ 147
$ 154
$ 161
$ 161
Add: Depreciation
$ 45
$ 55
$ 60
$ 65
Operating cash flow
$ 192
$ 209
$ 221
$ 226
Investment
$ 40
$ 43
$ 46
$ 48
Free cash flow
$ 152
$ 166
$ 175
$ 178
After tax cost of debt = Interest rate * (1 – Tax rate) = 4% * (1-0.30) = 2.80%
Cost of equity = Risk free rate + (Beta*Market risk premium) = 6% + (0.80*10%) = 6% + 8% = 14%
Weight of debt = 20%
Weight of equity = 80%
Weighted average cost of capital (WACC) = (Weight of debt*Cost of debt) + (weight of equity*Cost of equity) = (20%*2.80%) + (80%*14%) = 11.76%
This WACC shall be used as discount rate for discounting the free cash flows.
Terminal value at the end of year 4 = Free cash flow for year 4/WACC = $178 million/0.1176 = $1,513.61 million
Year
(in millions)
Present value at 11.76%
Present value of cash flows (in millions)
1
Free cash flow
$ 152.00
0.8948
$ 136.01
2
Free cash flow
$ 166.00
0.8006
$ 132.90
3
Free cash flow
$ 175.00
0.7164
$ 125.37
4
Free cash flow
$ 178.00
0.641
$ 114.10
4
Terminal value
$ 1,513.61
0.641
$ 970.22
$ 1,478.60
Hence value of Buildwell corporation = $1,478.60 million
Value of debt = $1,478.60 million * 20% = $295.72 million
Value of equity = $1,478.60 million * 80% = $1,182.88 million
(in millions)
Year
1
2
3
4
EBITDA
$ 255
$ 275
$ 290
$ 295
Depreciation
$ 45
$ 55
$ 60
$ 65
Profit before tax
$ 210
$ 220
$ 230
$ 230
Tax at 30%
$ 63
$ 66
$ 69
$ 69
Profit after tax
$ 147
$ 154
$ 161
$ 161
Add: Depreciation
$ 45
$ 55
$ 60
$ 65
Operating cash flow
$ 192
$ 209
$ 221
$ 226
Investment
$ 40
$ 43
$ 46
$ 48
Free cash flow
$ 152
$ 166
$ 175
$ 178
Related Questions
drjack9650@gmail.com
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.