Problem 1: Value of Assets 0% Debt/ 25% Debt/ 50% Debt/ 100% Equity 75% Equity 5
ID: 2797080 • Letter: P
Question
Problem 1: Value of Assets 0% Debt/ 25% Debt/ 50% Debt/ 100% Equity 75% Equity 50% Equity Book Value of Debt - $2,500 $5,000 Book Value of Equity $10,000 $7,500 $5,000 Market Value of Debt - $2,500 $5,000 Market Value of Equity $10,000 $8,350 $6,700 Pretax Cost of Debt 5.00% 5.00% 5.00% After-Tax Cost of Debt 3.30% 3.30% 3.30% Market Value Weights of Debt 0% Equity 100% Levered Beta 0.80 Risk-Free Rate 5.0% 5.0% 5.0% Market Premium 6.0% 6.0% 6.0% Cost of Equity Weighted-Average Cost of Capital EBIT $1,485 $1,485 $1,485 Taxes (@ 34%) EBIAT + Depreciation $500 $500 $500 - Capital exp. ($500) ($500) ($500) + Change in net working capital - - - Free Cash Flow Value of Assets (FCF/WACC)
Explanation / Answer
value of assets Debt 0 25% 50% Equity 100% 75% 50% Book value of debt 0 2500 5000 Book value of equity 10000 7500 5000 MV of debt 0 2500 5000 MV of equity 10000 8350 6700 Required rate of return = Rf + Beta (Rm - Rf) = 5.0% + 0.80 (6.0%) = 9.80% cost of debt 3.3 3.3 3.3 cost of eqity 9.8 9.8 9.8 Cost of capital = 3.30 x 0% + 9.80 x 100% = 9.80% Note : Debtweight 0% and equity 100% given in question EBIT 1485 1485 1485 TAX @ 34% 505 505 505 EAT 980 980 980 Capital Exp-Dep. 0 0 0 (Dep 500 - cap exp 500) Change in net Wcapital 0 0 0 FREE CASH FLOWS = 980 980 980 Free cash flow of assets = FCF / WACC $10,001.02 $ 10,001.02 $ 10,001.02