Tom is a financial analyst who is required to value Kago Ltd. at the end of 2022. Kago Ltd. is a software company with high growth and very high profitability for the recent two years. 

It mainly conducts B2B business and provides software solutions to other firms. Hence, contracts with customers normally involve large amounts, with small contracts amounting to more than $50,000. The cash payment cycle from customers significantly varies across contracts. The company is entirely unleveraged now, that is, without lease liabilities and borrowings. An external financial advisor has suggested to its CFO that if Kago Ltd. plans to issue corporate bonds in the market, their coupon interest rate is estimated to be 6.00%. All paid interest expenses are tax deductible at the corporate tax rate 30%.

 

Additional information collected by Tom is as follows: 

• The 30-year government bond issued by the country that Kago Ltd makes most of its business in is 2.05%.

 • The beta for Kago is 1.35.

 • The return of the market portfolio is 3.50%

 

i. Calculate the WACC for Kago Ltd. to two decimal places (e.g., 8.00%).

ii. For intrinsic valuation approach, Tom is debating which financial measure to use to forecast Kago Ltd.'s long-term growth rate. He is considering two potential choices: EBITDA and FCFF. Advise which one of these two financial measures is better for predicting Kago Ltd.'s long-term growth. Explain why.

iii. Tom finds that Kago's estimated equity value based on the relative valuation approach using the price-to-earnings ratio is substantially lower than that estimated based on the intrinsic valuation approach using the free-cash-flow model. List three potential reasons to explain why this is the case.

Answer rating: 100% (QA)

SOLUTION i To calculate the WACC for Kago Ltd we can use the following formula WACC EV Re DV Rd 1 T where E market value of equity V total firm value ... View the full answer