In year 1, AMC will earn $2,500 before interest and taxes. The market expects these earnings to grow at a rate of 2.7% per year. The firm will make no net investments (i.e., capital expenditures will equal depreciation) or changes to net working capital. Assume that the corporate tax rate equals 25%. Right now, the firm has $6,250 in risk-free debt. It plans to keep a constant ratio of debt to equity every year, so that on average the debt will also grow by 2.7% per year. Suppose the risk-free rate equals 4.5%, and the expected return on the market equals 9.9%. The asset beta for this industry is 1.28. a. If AMC were an all-equity (unlevered) firm, what would its market value be? b. Assuming the debt is fairly priced, what is the amount of interest AMC will pay next year? If AMC's debt is expected to grow by 2.7% per year, at what rate are its interest payments expected to grow? c. Even though AMC's debt is riskless (the firm will not default), the future growth of AMC's debt is uncertain, so the exact amount of the future interest payments is risky. Assuming the future interest payments have the same beta as AMC's assets, what is the present value of AMC's interest tax shield? d. Using the APV method, what is AMC's total market value, V? What is the market value of AMC's equity? e. What is AMC's WACC? (Hint: Work backward from the FCF and V.) f. Using the WACC, what is the expected return for AMC equity? E D g. Show that the following holds for AMC: PAD+EE+D+ED h. Assuming that the proceeds from any increases in debt are paid out to equity holders, what cash flows do the equity holders expect to receive in one year? At what rate are those cash flows expected

Financial Management: Theory & Practice
16th Edition
ISBN:9781337909730
Author:Brigham
Publisher:Brigham
Chapter7: Corporate Valuation And Stock Valuation
Section: Chapter Questions
Problem 1P: Ogier Incorporated currently has $800 million in sales, which are projected to grow by 10% in Year 1...
Question
None
In year 1, AMC will earn $2,500 before interest and taxes. The market expects these earnings to grow at a rate of 2.7% per year. The firm will make no net investments (i.e., capital expenditures will
equal depreciation) or changes to net working capital. Assume that the corporate tax rate equals 25%. Right now, the firm has $6,250 in risk-free debt. It plans to keep a constant ratio of debt to equity
every year, so that on average the debt will also grow by 2.7% per year. Suppose the risk-free rate equals 4.5%, and the expected return on the market equals 9.9%. The asset beta for this industry is 1.28.
a. If AMC were an all-equity (unlevered) firm, what would its market value be?
b. Assuming the debt is fairly priced, what is the amount of interest AMC will pay next year? If AMC's debt is expected to grow by 2.7% per year, at what rate are its interest payments expected to grow?
c. Even though AMC's debt is riskless (the firm will not default), the future growth of AMC's debt is uncertain, so the exact amount of the future interest payments is risky. Assuming the future interest payments
have the same beta as AMC's assets, what is the present value of AMC's interest tax shield?
d. Using the APV method, what is AMC's total market value, V? What is the market value of AMC's equity?
e. What is AMC's WACC? (Hint: Work backward from the FCF and V.)
f. Using the WACC, what is the expected return for AMC equity?
E
D
g. Show that the following holds for AMC: PAD+EE+D+ED
h. Assuming that the proceeds from any increases in debt are paid out to equity holders, what cash flows do the equity holders expect to receive in one year? At what rate are those cash flows expected
Transcribed Image Text:In year 1, AMC will earn $2,500 before interest and taxes. The market expects these earnings to grow at a rate of 2.7% per year. The firm will make no net investments (i.e., capital expenditures will equal depreciation) or changes to net working capital. Assume that the corporate tax rate equals 25%. Right now, the firm has $6,250 in risk-free debt. It plans to keep a constant ratio of debt to equity every year, so that on average the debt will also grow by 2.7% per year. Suppose the risk-free rate equals 4.5%, and the expected return on the market equals 9.9%. The asset beta for this industry is 1.28. a. If AMC were an all-equity (unlevered) firm, what would its market value be? b. Assuming the debt is fairly priced, what is the amount of interest AMC will pay next year? If AMC's debt is expected to grow by 2.7% per year, at what rate are its interest payments expected to grow? c. Even though AMC's debt is riskless (the firm will not default), the future growth of AMC's debt is uncertain, so the exact amount of the future interest payments is risky. Assuming the future interest payments have the same beta as AMC's assets, what is the present value of AMC's interest tax shield? d. Using the APV method, what is AMC's total market value, V? What is the market value of AMC's equity? e. What is AMC's WACC? (Hint: Work backward from the FCF and V.) f. Using the WACC, what is the expected return for AMC equity? E D g. Show that the following holds for AMC: PAD+EE+D+ED h. Assuming that the proceeds from any increases in debt are paid out to equity holders, what cash flows do the equity holders expect to receive in one year? At what rate are those cash flows expected
Expert Solution
steps

Step by step

Solved in 2 steps with 7 images

Blurred answer
Similar questions
  • SEE MORE QUESTIONS
Recommended textbooks for you
Financial Management: Theory & Practice
Financial Management: Theory & Practice
Finance
ISBN:
9781337909730
Author:
Brigham
Publisher:
Cengage
EBK CONTEMPORARY FINANCIAL MANAGEMENT
EBK CONTEMPORARY FINANCIAL MANAGEMENT
Finance
ISBN:
9781337514835
Author:
MOYER
Publisher:
CENGAGE LEARNING - CONSIGNMENT
Intermediate Financial Management (MindTap Course…
Intermediate Financial Management (MindTap Course…
Finance
ISBN:
9781337395083
Author:
Eugene F. Brigham, Phillip R. Daves
Publisher:
Cengage Learning