Valuation Methodologies
ABC, Inc., is an unlevered venture that reached its mature life-cycle stage. ABC is expecting earnings before taxes of $30 million in perpetuity. The required return of the firm’s unlevered equity (rU) is 18 percent, and the firm distributes all of its earnings as dividends at the end of each year. ABC has 1 million shares of common stock outstanding and is subject to a corporate tax rate of 34 percent. The firm is planning a recapitalization under which it will issue $50 million of perpetual 10 percent debt and use the proceeds to buy back shares.
1. Calculate the value of ABC before the recapitalization plan is announced. What is the value of ABC’s equity before the announcement? What is the price per share?
2. Use the APV method to calculate the value of ABC after the recapitalization period is announced. What is the value of ABC’s equity after the announcement? What is the price per share?
3. How many shares will be repurchased? What is ABC’s equity value after the repurchase has been complete? What is the price per share?
4. Use the flow-to-equity method to calculate the value of ABC’s equity after the recapitalization.