Acme Storage has a market capitalization of $ 214 million, and debt outstanding

ID: 2794952 • Letter: A

Question

Acme Storage has a market capitalization of $ 214 million, and debt outstanding of$ 220

million. Acme plans to maintain this same debt-equity ratio in the future. The firm pays an interest of 8.9%

on its debt and has a corporate tax rate of 35%.

a. If Acme's free cash flow is expected to be

$30.38 million next year and is expected to grow at a rate of 4%

per year, what is Acme's WACC?

b. What is the value of Acme's interest tax shield?

a. If Acme's free cash flow is expected to be

$ 30.38 million next year and is expected to grow at a rate of 4 %

per year, what is Acme's WACC?The WACC is 11%.

(Round to the nearest integer.)

b. What is the value of Acme's interest tax shield?

The value of Acme's interest tax shield is

$ million. (Round to two decimal places.)

Answer a) WACC = weight of debt* cost of debt *(1-tax rate) + weight of equity * cost of equity

Weight of debt = 220/(220+214) = 50.691%

Weight of equity = (1- 0.50691) = 49.309%

WACC = 50.691%*8.9%*(1-0.35) + 49.309%*cost of equity

Cost of equity is calculated as

Equity value of firm = Free cash flow / (Cost of equity - growth)

214 = 30.38 / (Cost of eq - 0.04)

Cost of equity - 0.04 = 30.38 / 214

Cost of equity = 0.141963 + 0.04 = 0.1819 or 18.19%

50.691%*8.9%*(1-0.35) + 49.309%*18.19%

=11.905%

Answer ) Tax shield = 220,000,000 x 8.9% x 35% = 6853,000 or 6.85 million

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.