Canton Corporation is a privately owned firm that engages in the production and sale of industrial chemicals,
Question:
To support its analysis, the investment banker has prepared pro forma financial statements for each of the next four years under the (simplifying) assumption that firm sales are flat (i. e., have a zero rate of growth), the corporate tax rate equals 30%, and capital expenditures are equal to the estimated depreciation expense.
In addition to the financial information on Canton, the investment banker has as-sembled the following information concerning current rates of return in the capital market:
The current market rate of interest on ten-year Treasury bonds is 7%, and the market risk premium is estimated to be 5%.
Cantons debt currently carries a rate of 8%, and this is the rate the firm would have to pay for any future borrowing as well.
Using publicly traded firms as proxies, the estimated equity beta for Canton is 1.60.
a. What is Cantons cost of equity capital? What is the after-tax cost of debt for the firm?
b. Calculate the equity free cash flows for Canton for each of the next four years. Assuming that equity free cash flows are a level perpetuity for year 5 and beyond, estimate the value of Cantons equity. (Equity value is equal to the present value of the equity free cash flows discounted at the levered cost of equity.) If the of interest on Cantons debt is equal to the 8% coupon, what is the cur-rent market value of the firms debt? What is the enterprise value of Canton? (Enterprise value can be estimated as the sum of the estimated values of the firms interest-bearing debt plus equity.)
c. Using the market values of Cantons debt and equity calculated in Problem 9-5( b), calculate the firms after-tax weighted average cost of capital.
d. What are the FCFs for Canton for years 1 through 4?
e. Estimate the enterprise value of Canton using the traditional WACC model. Base your estimate on your previous answers, and assume that the FCFs after year 4 are a level perpetuity equal to the year 4 FCF. How does your estimate compare to your earlier estimate using the sum of the values of the firms debt and equity?
f. Based on your estimate of enterprise value, what is the value per share of equity for the firm if the firm has 2 million shares outstanding? Remember that your calculations up to this point have been in thousands of dollars.
Financial statements are the standardized formats to present the financial information related to a business or an organization for its users. Financial statements contain the historical information as well as current period’s financial... Corporation
A Corporation is a legal form of business that is separate from its owner. In other words, a corporation is a business or organization formed by a group of people, and its right and liabilities separate from those of the individuals involved. It may... Cost Of Debt
The cost of debt is the effective interest rate a company pays on its debts. It’s the cost of debt, such as bonds and loans, among others. The cost of debt often refers to before-tax cost of debt, which is the company's cost of debt before taking... Perpetuity
Perpetuity refers to payments that are made without an end or maturity date. A perpetuity is classified as an annuity, which is something that earns a dividend or receives a payment at a regularly scheduled interval, generally yearly. So, how...
Step by Step Answer:
Valuation The Art and Science of Corporate Investment Decisions
ISBN: 978-0133479522
3rd edition
Authors: Sheridan Titman, John D. Martin