Question 1:
HiFlyer Corporation does not currently have any debt. Its tax rate is 0.4 and its unlevered beta is estimated by examining comparable companies to be 2.0. The 10-year Treasury bond rate is 6.25% and the historical risk premium over the risk free rate is 5.5%.
a. Calculate the firms current cost of equity.
b. Estimate the firms cost of equity after it increases its leverage to 75% of equity?
Question 2:
ABC Incorporated shares are currently trading for $32 per share. The firm has 1.13 billion shares outstanding. In addition, the market value of the firms outstanding debt is $2 billion. The 10-year Treasury bond rate is 6.25%. ABC has an outstanding credit record and has earned an AAA rating from the major credit rating agencies. The current interest rate on AAA corporate bonds is 6.45%. The historical risk premium for stocks over the risk-free rate of return is 5.5 percentage points. The firms beta is estimated to be 1.1 and its marginal tax rate, including federal, state, and local taxes is 40%.
a. What is the cost of equity?
b. What is the after-tax cost of debt?
c. What is the cost of capital?
Question 3:
Abbreviated financial statements are given for Fletcher Corporation in the following table:
Yearend working capital in 2018 was $160 million and the firms marginal tax rate is 40% in both 2019 and 2020. Estimate the following for 2019 and 2020:
a. Free cash flow to equity.
b. Free cash flow to the firm.
Question 4:
No Growth Incorporated had operating income before interest and taxes in 2011 of $220 million. The firm was expected to generate this level of operating income indefinitely. The firm had depreciation expense of $10 million that same year. Capital spending totaled $20 million during 2011. At the end of 2010 and 2011, working capital totaled $70 and $80 million, respectively. The firms combined marginal state, local, and federal tax rate was 40% and its debt outstanding had a market value of $1.2 billion. The 10-year Treasury bond rate is 5% and the borrowing rate for companies exhibiting levels of creditworthiness similar to No Growth is 7%. The historical risk premium for stocks over the risk free rate of return is 5.5%. No Growths beta was estimated to be 1.0. The firm had 2,500,000 common shares outstanding at the end of 2011. No Growths target debt to total capital ratio is 30%.
a. Estimate free cash flow to the firm in 2011.
b. Estimate the firms cost of capital.
c. Estimate the value of the firm (i.e., includes the value of equity and debt) at the end of 2011, assuming that it will generate the value of free cash flow estimated in (a) indefinitely.
d. Estimate the value of the equity of the firm at the end of 2011.
e. Estimate the value per share at the end of 2011.
Question 5:
Ergo Unlimiteds current years free cash flow is $10 million. It is projected to grow at 20% per year for the next five years. It is expected to grow at a more modest 5% beyond the fifth year. The firm estimates that its cost of capital is 12% during the next five years and then will drop to 10% beyond the fifth year as the business matures. Estimate the firms current market value.
Question 6:
In the year in which it intends to go public, a firm has revenues of $20 million and net income after taxes of $2 million. The firm has no debt, and revenue is expected to grow at 20% annually for the next five years and 5% annually thereafter. Net profit margins are expected remain constant throughout. Capital expenditures are expected to grow in line with depreciation and working capital requirements are minimal. The average beta of a publicly-traded company in this industry is 1.50 and the average debt/equity ratio is 20%. The firm is managed very conservatively and does not intend to borrow through the foreseeable future. The Treasury bond rate is 6% and the tax rate is 40%. The normal spread between the return on stocks and the risk free rate of return is believed to be 5.5%. Reflecting the slower growth rate in the sixth year and beyond, the firms discount rate is expected to decline to the industry average cost of capital of 10.4%. Estimate the value of the firms equity.
