a. Estimate the target firm’s asset beta. (Round your answer to 2 decimal places.) b. Estimate the target’s unlevered, or all-equity, cost of capital (KA). (Round your answer to 1 decimal place.) c. Estimate the target’s all-equity present value. (Enter your answer in millions rounded to 2 decimal places.)

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
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A group of investors is intent on purchasing a publicly traded company and wants to estimate the highest price they can reasonably justify paying. The target company’s equity beta is 1.20 and its debt-to-firm value ratio, measured using market values, is 60 percent. The investors plan to improve the target’s cash flows and sell it for 12 times free cash flow in year five. Projected free cash flows and selling price are as follows.

 

  ($ millions)
Year 1 2 3 4 5
Free cash flows $33 $48 $53 $58 $ 58  
Selling price         $ 696  
Total free cash flows $33 $48 $53 $58 $ 754  
 

 

To finance the purchase, the investors have negotiated a $480 million, five-year loan at 8 percent interest to be repaid in five equal payments at the end of each year, plus interest on the declining balance. This will be the only interest-bearing debt outstanding after the acquisition.

 

Selected Additional Information
Tax rate 40 percent
Risk-free interest rate 3 percent
Market risk premium 5 percent
 

 

a. Estimate the target firm’s asset beta. (Round your answer to 2 decimal places.)

b. Estimate the target’s unlevered, or all-equity, cost of capital (KA). (Round your answer to 1 decimal place.)

c. Estimate the target’s all-equity present value(Enter your answer in millions rounded to 2 decimal places.)

 

 

 

 
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