Good Name (GN) Inc. is expecting earnings before interest and taxes of $500,00 n

Question

Good Name (GN) Inc. is expecting earnings before interest and taxes of $500,00 next year in addition to depreciation expenses of $80,000, and increase in net working capital of $35,000, and an increase in capital spending of $60,000. They expect all of these to grow in perpetuity by 2% every year. GN stock has a required rate of return on equity of 8% and a yield-to-maturity on its debt of 5%. Assume the corporate tax rate for this problem is 0%. The firm's debt-to-equity ratio is currently 1.6 . what is the current value of the entire company?

THE ANSWER IS $11,675,926. But I dont know how they got this answet. Please answer it in a simple way. Thanks

Explanation / Answer

Weighted average Cost of capital = Weight of Equity * cost of equity + Weight of Debt * cost of Debt

Cost of Debt = 5% (since the tax rate is 0%)

Cost of Equity = 8%

Debt to Equity Ratio = 1.6

So Debt to Assets will be 1.6/ (1.6+1) since weights is equivalent to overall capital structure and or the overall assets

Or, Weight of Debt = 1.6/2.6 = 0.62

Weight of Equity = 1- Weight of Debt = 1-0.62 = 0.38

So, weighted average cost of capital = 5%*0.62 + 8%*0.38 = 6.1538% (approx)

Again, we need to calculate the free cash flows for the company (FCFF) = EBIT* (1-T) + Depreciation - Capital Spending – Change in Net Working Capital

EBIT (1-T) = $500,000

Depreciation = $80,000

Capital Spending = $60,000

Change in Working Capital = $35000

So, FCFF = $500,000 + $80,000 - $60,000 - $35000 = $485000

So, Value of the Entire Company = FCFF * (1 + Growth rate) / Average Cost of Capital – Growth Rate

Again, the value of the FCFF was obtained for the next year which suggest that growth rate has already been adjusted, so;

Value of the entire firm = $485,000/ (0.061538-0.02) = $1, 16, 76056

So this value is almost equal to the obtained one only difference is $129 and this because of the decimal in % of weighted average cost of capital.

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