Exe Plc. is expected to generate (before-tax) cash of 1.5m by the end of the year...

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Exe Plc. is expected to generate (before-tax) cash of £1.5m by the end of the year on an asset base which comprises £5m of fixed assets and £1m of working capital. Depreciation is 10% of the fixed asset base each year. It has a WACC of 8%. The firm has £2.5m of debt (book and market values are equal) outstanding at an interest rate of 6%. Cash taxes are payable at 30% of net profits. The firm can expand at 5% p.a. in perpetuity whilst maintaining returns to scale ("replacement" of assets = "depreciation") if debt also increases at 5% pa. (a) What are the value of the firm and the value of the equity? (b) What is the cost of equity capital? (c) Assume that the firm wishes to maintain leverage at a constant level and without issuing external new equity or grows at the sustainable growth rate. What will the dividend payout ratio need to be? (d) Show that an identical answer using all four methods: DDM, FCF, RIVM and P/E. Exe Plc. is expected to generate (before-tax) cash of £1.5m by the end of the year on an asset base which comprises £5m of fixed assets and £1m of working capital. Depreciation is 10% of the fixed asset base each year. It has a WACC of 8%. The firm has £2.5m of debt (book and market values are equal) outstanding at an interest rate of 6%. Cash taxes are payable at 30% of net profits. The firm can expand at 5% p.a. in perpetuity whilst maintaining returns to scale ("replacement" of assets = "depreciation") if debt also increases at 5% pa. (a) What are the value of the firm and the value of the equity? (b) What is the cost of equity capital? (c) Assume that the firm wishes to maintain leverage at a constant level and without issuing external new equity or grows at the sustainable growth rate. What will the dividend payout ratio need to be? (d) Show that an identical answer using all four methods: DDM, FCF, RIVM and P/E.

Answer rating: 100% (QA)

SOLUTION a To calculate the value of the firm we can use the formula Value of the Firm Present Value of Free Cash Flows WACC First lets calculate the free cash flows We are given that the beforetax ca... View the full answer