6.10 Elizabeth, Inc. had OFCF of $10.0 million last year. The current 30-year Tr
ID: 2781591 • Letter: 6
Question
6.10 Elizabeth, Inc. had OFCF of $10.0 million last year. The current 30-year Treasury is at 400, the beta for Elizabeth, Inc. is 1.20, and the market risk premium is 7%. Elizabeth, Inc. has 6 million shares outstanding, a D/E ratio of 0.25, and two debt issues. The first issue has a market value of $20 million and a YTM of 8.25%. The second issue has a market value of $10 million and a YTM of 7.75%. The marginal tax rate for the company is 30%. The company has $2,000,000 of excess cash on the balance sheet. FCF is expected to grow at 20% this year, then at 10% next year, and at 2% indefinitely after that. a. (3 points) What is the current price of a share of Elizabeth, Inc.? b. (7 points) What is a share of Elizabeth, Inc. actually worth?Explanation / Answer
The firm has 30m in debt with D/E of 0.25 => Value of equity = 30 / 0.25 = 120
Current Share Price = 120 / 6 = $20...a)
Cost of equity, ke = Rf + beta x MRP = 4% + 1.2 x 7% = 12.40%
Cost of debt, kd = 20 / (20 + 10) x 8.25% + 10 / (20 + 10) x 7.75% = 8.08%
WACC = wd x kd x (1 - tax) + we x ke
= 0.25 / (1 + 0.25) x 8.08% x (1 - 30%) + 1 / (1 + 0.25) x 12.40%
= 11.05%
FCF0 = 10
This year, FCF1 = 10 x (1 + 20%) = 12.0, FCF2 = 12 x (1 + 10%) = 13.2, FCF3 = 13.2 x (1 + 2%) = 13.46
Terminal Value in year 2, TV2 = FCF3 / (WACC - g) = 13.46 / (11.05% - 2%) = $148.75
Firm Value today = FCF1 / (1 + WACC) + (FCF2 + TV2) / (1 + WACC)^2
= 12 / 1.1105 + (148.75 + 13.2) / 1.1105^2
= $142.12
Equity Value = Firm Value + Cash - Debt = 142.12 + 2 - 30 = $114.12
Value of each share = Equity Value / No. of shares = 114.12 / 6 = $19.02... b)
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