5. Read the case and answer questions based on the Cost of Capital (CC) method. Bain Capital is considering a potential candidate, PubCo, for a highly leveraged buyout. Bain will contribute 25% of the deal value into the new "Merger Sub" as cash infusion in exchange for equity. A syndicate led by JP Morgan has agreed to provide debt financing for the remaining 75%. After a thorough study of PubCo's peer firms, the analyst has determined that the applicable average P/E ratio should be 6, levered beta be 2.4, and debt-equity ratio be 0.3. The equity risk premium is 6.0%. The 10-year Treasury bond rate is 5.0%. The firm's marginal tax rate is 40%, and there is no cap on the tax deductibility of net interest expense. If the buyout can be completed in the current year 2014, then starting 2015 Bain Capital can initiate the operation reform with the aim to reduce PubCo's debt- equity ratio from 1.5 to the target level 0.05 within five years. After that, the firm's cost of equity is expected to be 10% and equity cash flow is expected to grow annually by 4.5%. The analyst also expects that PubCo's net income can reach $25 billion, and the market average P/E ratio remains unchanged in 2019. The detailed projected free cash flow to equity and debt-equity ratio for the five years from 2015 to 2019 are provided below: Assumptions Projected Equity CF ($billion) Debt-Equity ratio 2015 0.50 1.50 3| Page 2016 2017 2018 2019 0.90 1.70 3.30 6.50 0.64 0.27 0.12 0.05 Questions: a. What is the comparable unlevered beta? Show your work.
5. Read the case and answer questions based on the Cost of Capital (CC) method. Bain Capital is considering a potential candidate, PubCo, for a highly leveraged buyout. Bain will contribute 25% of the deal value into the new "Merger Sub" as cash infusion in exchange for equity. A syndicate led by JP Morgan has agreed to provide debt financing for the remaining 75%. After a thorough study of PubCo's peer firms, the analyst has determined that the applicable average P/E ratio should be 6, levered beta be 2.4, and debt-equity ratio be 0.3. The equity risk premium is 6.0%. The 10-year Treasury bond rate is 5.0%. The firm's marginal tax rate is 40%, and there is no cap on the tax deductibility of net interest expense. If the buyout can be completed in the current year 2014, then starting 2015 Bain Capital can initiate the operation reform with the aim to reduce PubCo's debt- equity ratio from 1.5 to the target level 0.05 within five years. After that, the firm's cost of equity is expected to be 10% and equity cash flow is expected to grow annually by 4.5%. The analyst also expects that PubCo's net income can reach $25 billion, and the market average P/E ratio remains unchanged in 2019. The detailed projected free cash flow to equity and debt-equity ratio for the five years from 2015 to 2019 are provided below: Assumptions Projected Equity CF ($billion) Debt-Equity ratio 2015 0.50 1.50 3| Page 2016 2017 2018 2019 0.90 1.70 3.30 6.50 0.64 0.27 0.12 0.05 Questions: a. What is the comparable unlevered beta? Show your work.
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
Related questions
Question
I dont understand how did they calculate the discounted cash flow for each year, I was getting wrong answrers, please help by explaining each step and also the terminal value
Transcribed Image Text:b. Calculate the cost of equity from 2015 to 2019. Show your work.
Answer:
Year
2015
2016
2017
2018
2019
D/E
1.50
0.64
0.27
0.12
0.05
Levered beta
3.86
2.82
2.37
2.18
2.09
Answer:
Continued in next page
c. Calculate the total present value of equity cash flow from 2015 to 2019. Show
your work.
2018
2019
Year
2015 0.282 0.50
COE Equity CF
2016 0.219 0.90
2017 0.192 1.70
0.181 3.30
0.176 6.50
PV (FCFE 2015-2019) = $5.89 B
Discounted CF
0.39
0.58
0.91
1.50
2.51
Cost of equity
0.282
0.219
0.192
0.181
0.176
Answer:
Terminal Value (2019) = $123.50 B
Discounted Terminal Value = $47.77 B
PV = $53.66 B
4| Page
d. What is PubCo's equity value in 2014, if we estimate the terminal value by
using a discounted cash flow growth model? Show your work.
Transcribed Image Text:5. Read the case and answer questions based on the Cost of Capital (CC) method.
Bain Capital is considering a potential candidate, PubCo, for a highly
leveraged buyout. Bain will contribute 25% of the deal value into the new "Merger
Sub" as cash infusion in exchange for equity. A syndicate led by JP Morgan has
agreed to provide debt financing for the remaining 75%. After a thorough study of
PubCo's peer firms, the analyst has determined that the applicable average P/E ratio
should be 6, levered beta be 2.4, and debt-equity ratio be 0.3. The equity risk
premium is 6.0%. The 10-year Treasury bond rate is 5.0%. The firm's marginal tax
rate is 40%, and there is no cap on the tax deductibility of net interest expense.
If the buyout can be completed in the current year 2014, then starting 2015
Bain Capital can initiate the operation reform with the aim to reduce PubCo's debt-
equity ratio from 1.5 to the target level 0.05 within five years. After that, the firm's
cost of equity is expected to be 10% and equity cash flow is expected to grow
annually by 4.5%. The analyst also expects that PubCo's net income can reach $25
billion, and the market average P/E ratio remains unchanged in 2019. The detailed
projected free cash flow to equity and debt-equity ratio for the five years from 2015 to
2019 are provided below:
Assumptions
Projected Equity CF ($billion)
Debt-Equity ratio
2015
0.50
1.50
Answer:
Bu= 2.03
3 | Page
Questions:
a. What is the comparable unlevered beta? Show your work.
2016 2017 2018 2019
0.90
1.70
3.30 6.50
0.64
0.27
0.12
0.05
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Step 1: a. Calculate the comparable unlevered beta as follows:
VIEWStep 2: b. Calculate the cost of equity from 2015 and 2019 as follows:
VIEWStep 3: c. Calculate the total present value of equity cash flows 2015 - 2019 as follows:
VIEWStep 4: d. Calculate the PV of P's equity value as follows:
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