Corporate finance Assignment

Topics: Free cash flow, Discounted cash flow, Cash flow Pages: 7 (1085 words) Published: September 14, 2014
1.Calculate TRUST’s company after-tax WACC. The risk-free rate was 4.21%, the market risk premium was 6% and the company tax rate was 30%. The WACC should be rounded to four decimal places.

After-tax WACC = rD (1-Tc) D/V + rE E/V

rE = rf + βequity(rm – rf)
rE = 0.0421 + 0.81(0.06)
rE = 0.0907

E = number of outstanding shares x current share price
E = 60 million x $3.43
E = $205.8 million

D = $44 million bank loans + $1.2 million short-term hire purchase commitments D = $45.2 million

V = $205.8 million + $45.2 million
V = $251 million

After-tax WACC = (1-0.3)(0.0348 x 44/251 + 0.0618 x 1.2/251) + 0.0907 x 205.8/251 After-tax WACC = 0.0789

Calculate the RV Division WACC using Stephens’s method in paragraph 20. rE = rf + βequity(rm – rf)
rE = 0.0421 + 2.1(0.06)
rE = 0.1681

Using TRUST’s debt-to-equity mix of 21%:
Pre-tax divisional WACC = 0.1442 = (rD x 0.21) + (0.1681 x 0.79)

From above:
rD = 0.0543

After-tax divisional WACC = (1-0.3)(0.0543 x 0.21) + (0.1681 x 0.79) After-tax divisional WACC = 0.1408

What could be deduced about the relative business risk of the RV Division compared to its industry competitors if the industry equity beta was 2.10? Using industry equity beta to determine the cost of equity suggests that the RV Division’s equity risk is the same as that of the industry. This indicates that the difference in business risk between the RV Division and its industry competitors will stem from TRUST’s choice of capital structure, i.e. level of debt to equity.

If RV was financed completely by equity, the cost of equity is the cost of capital for RV. Using the industry beta to determine rE suggests that RV’s equity risk is the same as that of the industry. The variation in business risk between RV and its industry competitors thus stems from the introduction of debt into the capital structure.

YearForecast
123456
Sales 220002321024487253442623126755
Variable cost132001392614692152061573816053
Fixed cost 200020602122218522512319
Dep'n 100011001200130014001500
Operating income580061246473665268416884
Tax (30%) 174018371942199620522065
Net income 406042874531465647894818
Depreciation100011001200130014001500
Operating cash flow506053875731595661896318
Investment in fixed assets120012001200120012001200
Investment in WC115121128868952
FCF 374540664403467149005066
Complete Table 1, in accordance with the given assumptions, to show the derivation of free cash flow in year 1 to year 6. ($’000, rounded to the nearest dollar)

Calculate the horizon value as of year 5 using the constant-growth discounted cash flow formula. Horizon value at year 5 = (FCF at year 6)/((WACC-g))= 5,066,015.74/(0.1408-0.02) = $41,937,216

Use an appropriate cost of capital and a presentation table similar to Table 2, show the discounted value of RV’s free cash flow in year 1 to year 5 plus that of the horizon value. What would be the present value of the RV Division on its own without expansion, rounded to the nearest thousand dollars? After-tax cash flow projections for the RV division ($'000) YearFCFDiscounted value at RV Division WACC (14.08%)

t=13745 3282.784011
t=24066 3124.114816
t=34403 2965.866589
t=44671 2757.669399
t=54900 2536.07564
PV at t=0 14666.51046

PV at t=0 = 3745/1.1408+ 4066/〖1.1408〗^2 + 4403/〖1.1408〗^3 + 4671/〖1.1408〗^4 + 4900/〖1.1408〗^5 = $14,666,510.46

PVhorizon = 41,937,216.39 x 1/〖1.1408〗^5 = $21,704,612.57 PVwithout expansion = PV(Cash flows years 1-5) + PV(Horizon value) PVwithout expansion = 14,666,510.46 + 21,704,612.57 = $36,371,123.03

PVwithout expansion (to the nearest thousand dollars) = $36,371,000

Reconstruct Table 2 again with the appropriate cost of capital to show the correct discounted value of the expansion cash flows in year 1 to year 5. Must show the appropriate NPVt=1...
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