Question

Jurgen Knudsen has been hired to provide industry expertise to Henrik Sandell, CFA, an analyst for a pension plan managing a global large-cap fund internally. Sandell is concerned about one of the fund's larger holdings, auto parts manufacturer Kruspa AB. Kruspa currently operates in 80 countries, with the previous year's global revenues at 5.6 billion. Recently, Kruspa's CFO announced plans for expansion into China. Sandell worries that this expansion will change the Additional information: 4.82% 4.25% 0.3 900 million 2.4 billion Equity risk premium, Sweden Risk-free rate of interest, Sweden Industry debt-to-equity ratio Market value of Kruspa's debt Market value of Kruspa's equity Kruspa's equity beta Kruspa's before-tax cost of debt China credit A2 country risk premium Corporate tax rate Interest payments each company's risk profile and wonders if he should recommend a sale of the position. Sandell provides Knudsen with the basic information. Kruspa's global annual free cash flow to the firm is 500 million and earnings are 400 million. Sandell estimates that tt Kruas atter- tax free cash flow to the firm on the China project for next three years is, respectively, 48 million, 52 million, and 54.4 million. Kruspa recently announced a dividend of 4.00 per ts that Knudsen ignore possible currency the Chinese plant to sell only to customers within China for the first Knudsen is asked to evaluate Kruspa's planned financing of the required 100 million with a 80 public offering of 10-year debt in Sweden and the remainder with an cash flow will level off f at a 2 percent rate of growth. Sandell also estimates 2 9.25% I .8896 375% Level share of stock. For the initial analysis, Sandell reques uctuations. FHe expects three years. ycar equity offering.

As part of the sensitivity analysis of the effect of the new project on the company’s cost of capital, Sandell is estimating the cost of equity of the China project considering that the China project requires a country equity premium to capture the risk of the project. What is the cost of equity for the project taking into account the country risk? USE THE FOLLOWING FORMULA TO CALCULATE IT: $re=risk free rate+\beta _{project}(Equity risk premium}-risk free rate)+Country risk premium$

Answer 1

Project Beta = Equity beta x (1 + (1 - tax) x Debt / Equity)

= 1.3 x (1 + (1 - 37.5%) x 900 / 2400)

= 1.60

Cost of equity = Rf + beta x ERP + CRP

= 4.25% + 1.60 x 4.82% + 1.88%

= 13.86%