Chapter 13, Problem 21QP

a.

Summary Introduction

To determine: The Maximum Price per Share.

Introduction:   The cost of equity is the yield than an investor anticipates from the security as returns for the risk they accept by spend in the specific security. Additionally it is the return an investor needs before they prefer for an alternative investment which pays higher than the correct.

The cost of debt is the effective interest rate of cost which a business earns on their current debts. Debt involves in the formation of capital structure. As the debt is considered as a deduction expenditure, the cost of debt is usually determined as after-tax cost in order to formulate similar to the cost of equity.

Answer to Problem 21QP

The Maximum Price per Share is $62.17

Explanation of Solution

Determine the Total Market Value

$\begin{array}{c}TotalMarketValue=\left[MarketValueofDebt+MarketValueofEquity\right]\\ =\left[\$140,000,000+\$380,000,000\right]\\ =\$\text{520,000,000}\end{array}$

Therefore the Total Market Value is $52,000,000

Determine the Weight of Debt and Equity

$\begin{array}{c}WeightofDebt=\left[\frac{MarketValueofDebt}{TotalMarketValue}\right]\\ =\left[\frac{\$140,000,000}{\$520,000,000}\right]\\ =0.269231or26.92\%\end{array}$

$\begin{array}{c}WeightofEquity=\left[\frac{MarketValueofEquity}{TotalMarketValue}\right]\\ =\left[\frac{\$380,000,000}{\$520,000,000}\right]\\ =0.730769or73.08\%\end{array}$

Therefore the Weight of Debt is 26.92% and Equity is 73.08%

Determine the WACC of the Company

$\begin{array}{c}WACC=\left[\left(Weigh{t}_{Debt}\times Rat{e}_{Debt}\right)\times \left(1-Tax\right)+\left(Weigh{t}_{Equity}\times Rat{e}_{Equity}\right)\right]\\ =\left[\left(26.92\times 6\%\right)\times \left(1-38\%\right)+\left(73.08\%\times 11\%\right)\right]\\ =\left[0.01001+0.08038\right]\\ =0.0904or9.04\%\end{array}$

Therefore the WACC of the Company is 9.04%

Determine the Cash Flow from Assets

Using a excel spreadsheet we compute the cash flow from assets as,

Excel Spreadsheet:

Excel Workings:

Determine the Terminal Value at the end of Year 5

$\begin{array}{c}Ter\min alValu{e}_{Year5}=\left[\frac{CashFlo{w}_{Year5}\times \left(1+GrowthRate\left(g\right)\right)}{\left(WACC-GrowthRate\left(g\right)\right)}\right]\\ =\left[\frac{\$11,314,565\times \left(1+3\%\right)}{\left(9.04\%-3\%\right)}\right]\\ =\left[\frac{\$11,654,001.74}{6.04\%}\right]\\ =\$192,947,048.74\end{array}$

Therefore the Terminal Value at the end of Year 5 is $192,947,048.74

Determine the Total Market Value of the Company

Using a excel spreadsheet we calculate the total value of company as,

Excel Spreadsheet:

Excel Workings:

Therefore the Total Market Value of the Company is $161,238,529.11

Determine the Total Market Value of Equity

$\begin{array}{c}MarketValueofEquity=\left[TotalMarketValueofCompany-DebtOuts\tan ding\right]\\ =\left[\$161,238,529.11-\$40,000,000\right]\\ =\$121,238,529.11\end{array}$

Therefore the Total Market Value of Equity is $121,238,529.11

Determine the Maximum Price per Share

$\begin{array}{c}Maximum\mathrm{Pr}icepershare=\left[\frac{MarketValueofEquity}{SharesOuts\tan ding}\right]\\ =\left[\frac{\$121,238,529.11}{1,950,000}\right]\\ =\$62.1736or\$62.17\end{array}$

Therefore the Maximum Price per Share is $62.17

b.

Summary Introduction

To determine: The New Estimate of Maximum Price per Share.

Answer to Problem 21QP

The Maximum Price per Share is $64.92

Explanation of Solution

Determine the Earnings Before Interest on Taxes, Depreciation and Amortization (EBITDA)

$\begin{array}{c}EBITDA=\left[EBI{T}_{Year5}+Depreciatio{n}_{Year5}\right]\\ =\left[\$24,596,880+\$1,967,750\right]\\ =\$26,564,630\end{array}$

Therefore the Earnings Before Interest on Taxes, Depreciation and Amortization (EBITDA) is $26,564,630

Determine the Terminal Value at the end of Year 5

$\begin{array}{c}Ter\min alValu{e}_{Year5}=\left[EBITDA\times \left(\frac{EV}{EBITDAMultiple}\right)\right]\\ =\left[\$26,564,630\times 8\right]\\ =\$212,517,040\end{array}$

Therefore the Terminal Value at the end of Year 5 is $212,517,040

Determine the Total Market Value of Company

Using a excel spreadsheet we calculate the total value of company as,

Excel Spreadsheet:

Excel Workings:

Therefore the Total Market Value of Company is $166,594,155.69

Determine the Total Market Value of Equity

$\begin{array}{c}MarketValueofEquity=\left[TotalMarketValueofCompany-DebtOuts\tan ding\right]\\ =\left[\$166,594,155.69-\$40,000,000\right]\\ =\$126,594,155.69\end{array}$

Therefore the Total Market Value of Equity is $126,594,155.69

Determine the New Estimate of Maximum Price per Share

$\begin{array}{c}Maximum\mathrm{Pr}icepershare=\left[\frac{MarketValueofEquity}{SharesOuts\tan ding}\right]\\ =\left[\frac{\$126,594,155.69}{1,950,000}\right]\\ =\$64.9200or\$64.92\end{array}$

Therefore the New Estimate of Maximum Price per Share is $64.92