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Problem 1:  Find the WACC for a firm with the following characteristics. 

Problem 1:  Find the WACC for a firm with the following characteristics.  A few years ago the firm

issued $4,000,000 debt with a coupon rate of 4%; currently that debt is trading with a yield to maturity of 5.5% and a value of $3,500,000.  The firm has 1,000,000 common shares outstanding at a value of $6/share.  You look up the asset beta for firms in the same industry (SIC) code and determine that value is 1.15.  The firm plans on keeping its D/E ratio constant (at the current level) going forward and the tax rate is expected to be 35%.  The beta of the firm’s debt is estimated as 0.10, the risk free rate is 3% and the market return is 9.8%.

Problem 2:  Suppose you want to estimate the cost of equity for a private company in the food industry that has similarities to Hormel Foods (HRL), Tyson Foods (TSN) and Conagra Foods (CAG).

  • Pull 36 months of monthly price data from Yahoo finance for each comp company.
  • Using the adjusted Close price calculate 35 monthly returns for each comp.
  • Calculate a levered beta for each comp using a regression analysis (use ^GSPC as the market return).
  • Un-lever the comp betas assuming that each company will have a constant D/E and a debt beta of 0. (find D from the “Key Statistics” section of Yahoo@ Finance “Total Debt (mrq); E is the Market Cap (intraday).  You can ignore cash.
  • Assume that the private company will also have a constant D/E ratio and re-lever your estimate of the asset beta to get a levered beta for the firm (assume that currently D is 5 billion and E is 20 billion and that the tax rate is 35%).
  • Assume a market risk premium of 5.5% and a risk free rate of 2.8% … what is the levered cost of equity?

Problem 3: Calculate the Project and Equity Free Cash Flows for the following scenario. We want to finance a project with 30% debt (70% equity).  We expect $1,000,000 in sales for next year; COGS to be 55% of sales; depreciation will be $400,000 and offset with $400,000 in new CAPEX.  Assume that Year 1 is the first year of a perpetuity with no growth (you get the t1 cash flow for ever).  The firm’s cost of debt is 4% (assume the debt is perpetual and you never pay down any principal); the cost of equity is 12%; the tax rate is 35%.  Hint: to determine the EFCF you will need to determine the value of the firm and the value of “D” so you can find the interest payment.

Problem 4: If the firm in Problem 4 were to decide to use 50% debt, how would the Project Free Cash Flow be affected?

Problem 1:  Find the WACC for a firm with the following characteristics.  A few years ago the firm

issued $4,000,000 debt with a coupon rate of 4%; currently that debt is trading with a yield to maturity of 5.5% and a value of $3,500,000.  The firm has 1,000,000 common shares outstanding at a value of $6/share.  You look up the asset beta for firms in the same industry (SIC) code and determine that value is 1.15.  The firm plans on keeping its D/E ratio constant (at the current level) going forward and the tax rate is expected to be 35%.  The beta of the firm’s debt is estimated as 0.10, the risk free rate is 3% and the market return is 9.8%.

Problem 2:  Suppose you want to estimate the cost of equity for a private company in the food industry that has similarities to Hormel Foods (HRL), Tyson Foods (TSN) and Conagra Foods (CAG).

  • Pull 36 months of monthly price data from Yahoo finance for each comp company.
  • Using the adjusted Close price calculate 35 monthly returns for each comp.
  • Calculate a levered beta for each comp using a regression analysis (use ^GSPC as the market return).
  • Un-lever the comp betas assuming that each company will have a constant D/E and a debt beta of 0. (find D from the “Key Statistics” section of Yahoo@ Finance “Total Debt (mrq); E is the Market Cap (intraday).  You can ignore cash.
  • Assume that the private company will also have a constant D/E ratio and re-lever your estimate of the asset beta to get a levered beta for the firm (assume that currently D is 5 billion and E is 20 billion and that the tax rate is 35%).
  • Assume a market risk premium of 5.5% and a risk free rate of 2.8% … what is the levered cost of equity?

Problem 3: Calculate the Project and Equity Free Cash Flows for the following scenario. We want to finance a project with 30% debt (70% equity).  We expect $1,000,000 in sales for next year; COGS to be 55% of sales; depreciation will be $400,000 and offset with $400,000 in new CAPEX.  Assume that Year 1 is the first year of a perpetuity with no growth (you get the t1 cash flow for ever).  The firm’s cost of debt is 4% (assume the debt is perpetual and you never pay down any principal); the cost of equity is 12%; the tax rate is 35%.  Hint: to determine the EFCF you will need to determine the value of the firm and the value of “D” so you can find the interest payment.

Problem 4: If the firm in Problem 4 were to decide to use 50% debt, how would the Project Free Cash Flow be affected?

 
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