1.A firm has unlevered beta of 1.1, and now its debt to equity ratio is 0.4. Wha
ID: 2809904 • Letter: 1
Question
1.A firm has unlevered beta of 1.1, and now its debt to equity ratio is 0.4. What is the levered beta assuming the tax rate is 40%?
2.Using WACC to discount free cash flows, one gets the value of the firm. True or False?
3.Suppose beta is 1.2, risk free rate is 3%, market risk premium is 5%, before tax cost of debt is 6%, tax rate is 40%, and the firm's debt to equity ratio is 0.5, what is WACC?
4.A firm has EBIT of 100 million, depreciation of 15 million, tax rate of 40%, change in net working capital of 3 million, and capital expenditure of 20 million, what is the free cash flow?
5.Suppose this free cash flow grows at 3% per year forever, and the WACC is 8%, what is the firm value?
6.If this firm has outstanding debt of 150 million, what is the equity value of the firm?
7.Suppose a firm has free cash flow of equity 100 million per year indefinitely, and its cost of equity is 10%, what is the equity value of this firm?
8.If this firm has outstanding debt of 250 million, what is the firm value?
Explanation / Answer
1. Levered Beta= Unelvered beta*(1+(1-tax rate)*D/E)
=1.1*(1+(1-0.40)*0.40)
=1.1*1.24= 1.364
2. Yes, It is true as while valauing a firm wth Free cashflow we discount it by WACC.
3.Cost of equity= RIsk free rate +Beta*(Market risk premium)
=3+1.2*(5) =9%
WACC =Equity/(debt+equity)*cost of equity+debt/(debt+equity)*cost of debt*(1-tax rate)
=0.5/1*0.09%+0.5/1*0.06*(1-0.40)
= 0.045+0.018
=6.3%
4.Free cash Flow= EBIT(1-T)+Dep-Capex-Change in working capital
=100*(1-0.40)+15-20-3 =$52Million
5.At the constant growth rate of 3% and WACC of 8%
Value of the firm= FCF(1+G)/(WACC-G)
=52*(1.03)/(0.08-0.03)
=$1071.20 Million
6. Equity value = Value of firm -debt
=1071.20-150= $921.20 million
7.It is the cae of perpetuity .
Equity value = FREE cash flow of equity/ cost of equity
=100/0.10 = $1000 million
8.Firm value= equity value + debt value
= 1000+250 = $1250 million
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