Corporate Finance
3rd Edition
ISBN: 9780132992473
Author: Jonathan Berk, Peter DeMarzo
Publisher: Prentice Hall
expand_more
expand_more
format_list_bulleted
Videos
Textbook Question
Chapter 12, Problem 23P
Weston Enterprises is an all-equity firm with two divisions. The soft drink division has an asset beta of 0.60, expects to generate
- a. Estimate the value of each division.
- b. Estimate Weston’s current equity beta and cost of capital. Is this cost of capital useful for valuing Weston’s projects? How is Weston’s equity beta likely to change over time?
Expert Solution & Answer
Want to see the full answer?
Check out a sample textbook solution
Students have asked these similar questions
Weston Enterprises is an all-equity firm with two divisions. The soft drink division has an asset beta of 0.52,
expects to generate free cash flow of $49 million this year, and anticipates a 4% perpetual growth rate. The
industrial chemicals division has an asset beta of 1.09, expects to generate free cash flow of $74 million this
year, and anticipates a 3% perpetual growth rate. Suppose the risk-free rate is 2% and the market risk premium
is 5%.
a. Estimate the value of each division.
b. Estimate Weston's current equity beta
c. Estimate Weston's current cost of capital. Is this cost of capital useful for valuing Weston's projects? How is
Weston's equity beta likely to change over time?
***
a. Estimate the value of each division.
The cost of capital for the soft drink division is%. (Round to two decimal places.)
Bhutapbhai
Suppose Alcatel-Lucent has an equity cost of capital of 10.2%, market capitalization of $11.20 billion, and an
enterprise value of $14 billion. Assume Alcatel-Lucent's debt cost of capital is 6.5%, its marginal tax rate is 33%, the
WACC is 9.03%, and it maintains a constant debt-equity ratio. The firm has a project with average risk. Expected free
cash flow, debt capacity, and interest payments are shown in the table:
a. What is the free cash flow to equity for this project?
b. What is its NPV computed using the FTE method? How does it compare with the NPV based on the
WACC method?
Data table
(Click on the following icon in order to copy its contents into a spreadsheet.)
Year
FCF ($ million)
D=dxv
Interest
0
1
2
3
- 100
55
103
74
38.84
31.34
13.57
0.00
0.00
2.52
2.04
0.88
to
Chapter 12 Solutions
Corporate Finance
Ch. 12.1 - According to the CAPM, we can determine the cost...Ch. 12.1 - What inputs do we need to estimate a firms equity...Ch. 12.2 - How do you determine the weight of a stock in the...Ch. 12.2 - Prob. 2CCCh. 12.2 - Prob. 3CCCh. 12.3 - How can you estimate a stocks beta from historical...Ch. 12.3 - How do we define a stocks alpha, and what is its...Ch. 12.4 - Why does the yield to maturity of a firms debt...Ch. 12.4 - Prob. 2CCCh. 12.5 - Prob. 1CC
Ch. 12.5 - Prob. 2CCCh. 12.6 - Why might projects within the same firm have...Ch. 12.6 - Under what conditions can we evaluate a project...Ch. 12.7 - Prob. 1CCCh. 12.7 - Prob. 2CCCh. 12 - Prob. 1PCh. 12 - Suppose the market portfolio has an expected...Ch. 12 - Prob. 3PCh. 12 - Suppose all possible investment opportunities in...Ch. 12 - Using the data in Problem 4, suppose you are...Ch. 12 - Prob. 6PCh. 12 - Prob. 7PCh. 12 - Suppose that in place of the SP 500, you wanted to...Ch. 12 - Prob. 9PCh. 12 - You need to estimate the equity cost or capital...Ch. 12 - In mid-2012, Ralston Purina had AA-rated, 10-year...Ch. 12 - Prob. 15PCh. 12 - Prob. 16PCh. 12 - Prob. 17PCh. 12 - Your firm is planning to invest in an automated...Ch. 12 - Prob. 19PCh. 12 - Prob. 20PCh. 12 - Prob. 21PCh. 12 - Weston Enterprises is an all-equity firm with two...Ch. 12 - Prob. 24PCh. 12 - Your company operates a steel plant. On average,...Ch. 12 - Prob. 26PCh. 12 - You would like to estimate the weighted average...Ch. 12 - Prob. 22P
Knowledge Booster
Learn more about
Need a deep-dive on the concept behind this application? Look no further. Learn more about this topic, finance and related others by exploring similar questions and additional content below.Similar questions
- Suppose Alcatel-Lucent has an equity cost of capital of 9.5%, market capitalization of $11.84 billion, and an enterprise value of $16 billion. Assume Alcatel-Lucent's debt cost of capital is 6.8%, its marginal tax rate is 35%, the WACC is 8.18%, and it maintains a constant debt-equity ratio. The firm has a project with average risk. Expected free cash flow, debt capacity, and interest payments are shown in the table a. What is the free cash flow to equity for this project? b. What is its NPV computed using the FTE method? How does it compare with the NPV based on the WACC method? Data table af (Click on the following icon in order to copy its contents into a spreadsheet.) Year 0 1 2 100 48 103 FCF ($ million) D=dxV 49.21 40.75 Interest 0.00 3.35 17.31 2.77 3 72 0.00 1.18 - Xarrow_forwardSuppose Alcatel-Lucent has an equity cost of capital of 10.3%, market capitalization of $11.20 billion, and an enterprise value of $14 billion. Assume Alcatel-Lucent's debt cost of capital is 6.5%, its marginal tax rate is 32%, the WACC is 9.12%, and it maintains a constant debt-equity ratio. The firm has a project with average risk. Expected free cash flow, debt capacity, and interest payments are shown in the table: a. What is the free cash flow to equity for this project? b. What is its NPV computed using the FTE method? How does it compare with the NPV based on the WACC method? a. What is the free cash flow to equity for this project? The free cash flow to equity for this project is: (Round all answers to two decimal places. Use a minus sign to indicate a negative number.) Year FCFE ($ million) 0 1 2 3arrow_forwardThe FMS Corporation needs to raise investment money amounting to $40 million in new equity. The firm’s market risk is βM = 1.4, which means the firm is believed to be riskier than the market average. The risk free interest rate is 2.8% and the average market return is 9% per year. What is the cost of equity for the $40 million?arrow_forward
- Suppose Alcatel-Lucent has an equity cost of capital of 9.1%, market capitalization of $10.36 billion, and an enterprise value of $14 billion. Assume Alcatel-Lucent's debt cost of capital is 5.5%, its marginal tax rate is 34%, the WACC is 7.68%, and it maintains a constant debt-equity ratio. The firm has a project with average risk. Expected free cash flow, debt capacity, and interest payments are shown in the table: a. What is the free cash flow to equity for this project? b. What is its NPV computed using the FTE method? How does it compare with the NPV based on the WACC method? a. What is the free cash flow to equity for this project? The free cash flow to equity for this project is: (Round all answers to two decimal places. Use a minus sign to indicate a negative number.) Year 1 2 FCFE ($ million) 0 3 Data table (Click on the following icon in order to copy its contents into a spreadsheet.) Year 1 FCF ($ million) D=dxV² 45 39.60 Interest 2.62 0 - 100 47.64 0.00 Print Done 2 99…arrow_forwardSimon Software Co. is trying to estimate its optimal capital structure. Right now, Simon has a capital structure that consists of 20 percent debt and 80 percent equity, based on market values. (Its D/S ratio is 0.25.) The risk-free rate is 6 percent and the market risk premium, rM - rRF, is 5 percent. Currently the company's cost of equity, which is based on the CAPM, is 12 percent and its tax rate is 40 percent. Find the new levered beta given the new capital structure (if it were to change its capital structure to 50 percent debt and 50 percent equity) using the Hamada equation. O 1.67 O 0.81 O 1.00 O 1.22 O 1.45arrow_forwardXYZ is currently an all-equity firm with a total market value of $1,000,000. Earnings beforeinterest and taxes (EBIT) are projected to be $80,000 if economic conditions are normal. Ifthere is strong expansion in the economy, then EBIT will be 20% higher. If there is arecession, then EBIT will be 30% lower. The three states of the economy are equallylikely. XYZ is considering a (perpetual) debt issue of $150,000 with an interest (i.e.,coupon) rate of 6%. The proceeds will be used to repurchase shares of stock. There arecurrently 25,000 shares outstanding. Suppose that XYZ pays no taxes (that is, the tax rateis 0%). a) Calculate earnings per share, EPS, under each of the three economic scenariosbefore any debt is issued.Also, calculate the percentage changes in EPS when the economy expands orenters a recession. b) Repeat part (a) assuming that XYZ goes through with the recapitalization (that is,XYZ issues debt to repurchase shares at the current market price). Explain yourfindings.arrow_forward
- Suppose Alcatel-Lucent has an equity cost of capital of 10.3%, market capitalization of $9.36 billion, and an enterprise value of $13 billion. Assume that Alcatel-Lucent's debt cost of capital is 7.3%, its marginal tax rate is 34%, the WACC is 8.7650%, and it maintains a constant debt-equity ratio. The firm has a project with average risk. The expected free cash flow, levered value, and debt capacity are as follows: Thus, the NPV of the project calculated using the WACC method is $182.73 million - $100 million = $82.73 million. a. What is Alcatel-Lucent's unlevered cost of capital? b. What is the unlevered value of the project? c. What are the interest tax shields from the project? What is their present value? d. Show that the APV of Alcatel-Lucent's project matches the value computed using the WACC method. a. What is Alcatel-Lucent's unlevered cost of capital? Alcatel-Lucent's unlevered cost of capital is%. (Round to four decimal places.) Data table (Click on the following icon in…arrow_forwardA firm has decided that its optimal capital structure is 100% equity-financed. It perceives its optimal dividend policy to be a 60% payout ratio. Asset turnover is sales/assets = 0.6, the profit margin is 10%, and the firm has a target growth rate of 3%. a-1. Calculate the sustainable growth rate. (Do not round intermediate calculations. Enter your answer as a percent rounded to 1 decimal place.) a-2. Is the firm’s target growth rate consistent with its other goals? b. If the firm’s target growth rate is not consistent with its other goals, what would asset turnover need to be to achieve its goals? (Do not round intermediate calculations. Round your answer to 3 decimal places.) c. If the firm’s target growth rate is not consistent with its other goals, how high would the profit margin need to be to achieve its goals? (Do not round intermediate calculations. Enter your answer as a percent rounded to 1 decimal place.)arrow_forwardSim Software Co trying to estimate its optimal capital structure. Right now, Simon has a capital structure that consists of 10 percent debt and 90 percent equity. The risk - free rate is 3 percent and the market risk premium is 8 percent. Currently, the company's cost of equity is 15 percent and its tax rate is 21 percent. What is the unlevered cost of equity?arrow_forward
- a) One of the touted advantages of an ERM system is the stabilization of revenuethat results in shareholders valuing the business highly on the markets. Assumea firm has operating free cash flows of K300 million, which is expected to grow at13% for four years. After four years, it will return to a normal growth rate of 8%.Assuming that the weighted average cost of capital is 12%. Calculate the valueof the firm. b) A project has a worked out IRR of 15%. Would you advise the companyto undertake this project at its current WACC? Give reasons for youranswer.arrow_forwardDocile Partners Limited (DPL) has two lines of business, organized as two divisions, A and B. Division A generates a risk-free cash flow. It will produce $1.79 million in free cash flow next year and it will grow at 1.19% each year thereafter forever. The second line of business, run by Division B, is risky. It expects to generate a cash flow of $3.03 million next year and will grow at a rate of 2.03%. Currently, the total market value of DPL is $116.8 million. The term structure of interest rates is flat at 3.44%. Show two decimal places for all your answers. (a) What is the dollar value of Division B? million (b) What is the cost of capital for Division B (in %)? % (c) Assume the company is planning on making an investment which will improve Division B's profitability. This project requires an initial investment of $6.8 million a year from now, and will increase cash flow by $0.96 million starting in year 2, as well as all future cash flows, so that their growth rate after year 2…arrow_forwardRolex, Inc. has equity with a market value of $20 million and debt with a market value of $20 million. Assume the firm has no default risk and can borrow at the risk-free interest rate. The risk-free interest rate is 5 percent per year, and the expected return on the market portfolio is 11 percent. The beta of the company's equity is 1.2. The tax rate is 20%. What is the cost of capital for an otherwise identical all-equity firm? O 7.77% O 9.00% O 10.14% O 8.27%arrow_forward
arrow_back_ios
SEE MORE QUESTIONS
arrow_forward_ios
Recommended textbooks for you
FIN 300 Lab 1 (Ryerson)- The most Important decision a Financial Manager makes (Managerial Finance); Author: AllThingsMathematics;https://www.youtube.com/watch?v=MGPGMWofQp8;License: Standard YouTube License, CC-BY
Working Capital Management Policy; Author: DevTech Finance;https://www.youtube.com/watch?v=yj-XbIabmFE;License: Standard Youtube Licence