Question

Q3. (10 Points) The debt-to-equity ratio of the CI Corp. is 0.5. To calculate the CI Corp's cost of equity, use the following information: The CI Corp's beta is 1.2, expected return on the market is 8%, and the risk-free rate is 2%. Its pretax cost of debt is 4%, what is the company's WACC? The tax rate is 35%. Q4. (10 Points) You are trying to estimate the value of the Smoothie company. The expected after-tax cashflows from assets for the next three years are $250m, $350m, and $500m, respectively. The cash flows are expected to grow at 3% thereafter forever. The estimated WACC is 9%. What is the value of the Smoothie company.?

Answer 1

3)

Expected return = risk free rate + beta * market risk premium

= 2% + 1.2 * (8% - 2%)

= 9.2%

debt/equity = 0.5

and debt + equity = 1

equity = 1/1.5 = 2/3

debt = 1/3

WACC = weight of debt * after tax cost of debt + weight of equity * cost of equity

= 2/3 * 4% * (1-0.35) + 1/3 * 9.2%

= 4.8%

4)

value of firm = Present value of FCF + Horizontal value

Horizontal value = FCF next year/(Required return - growth rate)

=>

horizontal value = 500 * 1.03/(0.09-0.03)

= 8583.33

value = 250/1.09 + 350/1.09^2 + 500/1.09^3 + 8583.33/1.09^3

= 7537.94 million