Caballos, Inc., has a debt to capital ratio of 30%, a beta of 1.39 and a pre-tax
ID: 2774353 • Letter: C
Question
Caballos, Inc., has a debt to capital ratio of 30%, a beta of 1.39 and a pre-tax cost of debt of 7.3%. The firm had earnings before interest and taxes of $ 590 million for the last fiscal year, after depreciation charges of $ 307 million. The firm had capital expenditures of $ 377 million, and non-cash working capital increased by $ 50 million. The firm also had a book value of capital of $ 2.04 billion at the beginning of the last fiscal year. (The treasury bond rate is 4.95 %, the market risk premium is 6.29 % and the firm has a tax rate of 40 %). Assume that the firm is in stable growth, and that the return on capital and reinvestment rates for the last fiscal year can be sustained forever. Estimate the Value of the Firm.
Explanation / Answer
Return on equity is Rf + beta * Rm Re 13.69% WACC = (% of equity) * Re +(% of debt) * Rd * (1 – Tc) WACC 10.90% EBIT 590 Capital expenditure 377 Increase in Working capital 50 Bookvalue 2040 Debt +equity ROC = EBIT POST TAX/Capital ROC 6.26% Free cash flow is EBIT = CAPITAL EXPENDITURE - INCREASE IN WORKING CAPITAL FCF 163 Terminal value = projected cash flow for final year (1 + long-term growth rate) / (discount rate - long-term growth rate) 3737.465 Value of firm 3900.465 Long term growth cannot be greater than discount rate