Total 12 marks) Apple Inc., a United States (U.S) based corporation, wants to purchase Technology Inc. a
Question:
Total 12 marks)
Apple Inc., a United States (U.S) based corporation, wants to purchase Technology Inc. a company based in China. The current U.S. Treasury bond rate is 5%. The expected inflation rate in the target company's country is 6% per annum compared to 3% in the U.S. The target company's country risk premium (CRP) provided by Standard & Poor's is estimated to be 2%. The target company's credit risk rating, based on its interest coverage ratio, is estimated to be AA. The current interest rate on a AA-rated U.S. corporate bond is 6.25%. Apple Inc. has a marginal income tax rate 40% and its pre-tax cost of debt is 6%. The firm's total capitalization consists only of common equity and debt. Furthermore, the projected debt to total capital ratio of Apple Inc. is 0.3.
The target company's beta and the country beta are estimated to be 1.3 and 0.7 respectively. The equity premium is estimated to be 6%, based on the spread between the prospective return on the country's equity index and the estimated risk free rate of return. Given the Technology Inc.'s current market capitalization of $3 billion, the firm size premium (FSP) is estimated at 1%.
What is the appropriate weighted average cost of capital Apple Inc. should use to discount target's projected annual cash flows, expressed in its own local currency? Show all your workings.