On behalf of your firm, you are evaluating a privately held takeover target. The table below contains cost of capital metrics for two comparable publicly traded firms that are in the same general business and are similar in size compared to the acquisition target. You decide to equally weight all the comp data to estimate the correct discount rate to use in valuing the target. The target will be financed with 20% debt, with a pretax cost of debt equal to 4%, and the debt beta is assumed to equal 0. Assume that all of the firms in your analysis are in the 35% tax bracket and that all of the firms have a policy to leave their debt ratio constant. Answer the following questions regarding the correct cost of capital to use in valuing the target. For all parts of this problem, assume a risk-free rate of 3% and a market risk premium of 6%.
a. What is the estimated firm or asset (unlevered equity) beta for the target firm based on the comp data?
b. What is the estimated levered cost of equity for the target based on the comp data and the target’s debt/ value ratio of 20%?
c. Using the equity cost already calculated and the information on the cost of debt in the problem, what is the WACC to use in discounting the target’s projected firm free cash flows?

  • CreatedNovember 13, 2015
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