Suppose Goodyear Tire and Rubber Company is considering divesting one of its man

Question

Suppose Goodyear Tire and Rubber Company is considering divesting one of its manufacturing plants. The plant is expected to generate free cash flows of $1.62 million per year, growing at a rate of 2.5% per year. Goodyear has an equity cost of capital of 8.4%, a debt cost of capital of 6.6%, a marginal corporate tax rate of 37%, and a debt-equity ratio of 2.4. If the plant has average risk and Goodyear plans to maintain a constant debt-equity ratio, what after-tax amount must it receive for the plant for the divestiture to be profitable? A divestiture would be profitable if Goodyear received more than S milion after tax. (Round to one decimal place.)

Explanation / Answer

We can compute the levered value of the plant using the WACC method.

Goodyear’s WACC is = 1/ (1 + 2.4) * 8.4% + (2.4/ (1 + 2.4)) * 6.6% * (1 - 37%)

Goodyear’s WACC is = 5.41%

Therefore value of levered = 1.62/ (5.41% - 2.5%)

Therefore value of levered = 55.75 million

A divestiture would be profitable if Goodyear received more than $55.75 million after tax

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