1) The CEO of Buffalo Bob’s Chicken Wings is considering selling her firm, and wants to know what it is worth. She estimates that the firm’s current year free cash flow is $4 million. She asks her CFO to create several estimates of the firm’s value. Scenario 1 is to be based on a 4% annual growth rate forever; the second scenario is to reflect a 6% annual growth rate for the next five years and 3% thereafter. The firm’s weighted average cost of capital for both scenarios is estimated to be 10%. What is the value of the firm under scenario 1 and scenario 2?
2) Joe’s Party Supply, Inc., currently has debt outstanding with a market value of $30.5 million and a yield to maturity of 6%. The company has an optimal (market value) debt-to-equity ratio of 0.37, and the required return on equity is 11%. EBIT for Joe’s next year is projected to be $12.5 million, and is expected to grow at 10% per year for the next four years before slowing to 3% growth in perpetuity. Change in net working capital, capital spending (capex), and depreciation as a percentage of EBIT are expected to be 9%, 15%, and 8%, respectively. Joe’s tax rate (applicable to EBIT) is 38%. Joe’s has 1.85 million shares outstanding: what is each one worth?
3) ABC Incorporated shares are currently trading for $32 per share. The firm has 1.13 billion shares outstanding. The market value of the firm’s debt is $2 billion. The 10-year Treasury bond rate is 6.25%. ABC as an outstanding credit rating and has earned a AAA rating from the major credit rating agencies: the current yield on AAA bonds is 6.45%. The historical equity market risk premium is 5.5%. ABC’s equity beta is estimated to be 1.1, and its marginal tax rate (including federal, state, local, and international taxes) is 40%.
a. What is ABC’s cost of equity?
b. What is ABC’s after-tax cost of debt?
c. What is ABC’s WACC?