3.3. The private company has only two components of debt. First, the target company has a...

Transcribed Image Text:

3.3. The private company has only two components of debt. First, the target company has a 3-year bank loan with a face value of 30M and annual interest expense rate of 6%. Second, the target company has a lease contract with three committed payments as follows: Years from now Lease Payment 1 15M 4 A1 +2.5% 3 20M Based on the synthetic credit rating approach, you just figure out that this company's key financial ratios are very similar to an "A3" credit rating company based on Moody's rating system and current credit spreads are provided below: 5 20M Moody's Rating Aaa A3 +3.0% Credit Spread +0.25% Further, you have decided to use the current 30-year T-bond rate, 2%, as the risk-free rate in your computation. A2 +2.8% Now, first compute the pre-tax cost of debt based on the synthetic rating approach. Then compute the total market value of debt for this private firm. 3.4. The acquirer believes that the target is under its optimal capital structure and has no intention to change it. The total firm value is estimated as 10X EBITDA based on the forecasted EBITDA of 20M for this fiscal year. You are going to use the estimated market value of firm based on EBITDA multiple to compute capital structure parameters, e.g., weights of debt and equity in total firm value. What is the WACC of standalone target firm under the current capital structure? Assume that you will use the market risk premium 5.5% based on the historical data and you maintain the same risk-free rate assumption (i.e., 2%) and cost of debt in 3.3. The target company has no preferred stocks. 3.3. The private company has only two components of debt. First, the target company has a 3-year bank loan with a face value of 30M and annual interest expense rate of 6%. Second, the target company has a lease contract with three committed payments as follows: Years from now Lease Payment 1 15M 4 A1 +2.5% 3 20M Based on the synthetic credit rating approach, you just figure out that this company's key financial ratios are very similar to an "A3" credit rating company based on Moody's rating system and current credit spreads are provided below: 5 20M Moody's Rating Aaa A3 +3.0% Credit Spread +0.25% Further, you have decided to use the current 30-year T-bond rate, 2%, as the risk-free rate in your computation. A2 +2.8% Now, first compute the pre-tax cost of debt based on the synthetic rating approach. Then compute the total market value of debt for this private firm. 3.4. The acquirer believes that the target is under its optimal capital structure and has no intention to change it. The total firm value is estimated as 10X EBITDA based on the forecasted EBITDA of 20M for this fiscal year. You are going to use the estimated market value of firm based on EBITDA multiple to compute capital structure parameters, e.g., weights of debt and equity in total firm value. What is the WACC of standalone target firm under the current capital structure? Assume that you will use the market risk premium 5.5% based on the historical data and you maintain the same risk-free rate assumption (i.e., 2%) and cost of debt in 3.3. The target company has no preferred stocks.

Answer rating: 100% (QA)

To compute the pretax cost of debt based on the synthetic rating approach we need to determine the credit spread associated with the target companys s... View the full answer