V2 C4 A3 Q6 You have been asked to value one of the biggest global companies, Ma
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Question
V2 C4 A3 Q6
You have been asked to value one of the biggest global companies, Malicaca, Inc., but using only the information provided to you (modified to camouflage the real identity of the company). Malicaca, Inc. is expected to have revenues of $500 million next year (t = 1) that are expected to grow at 8% per year thereafter for the foreseeable future. The data presented to you shows that COGS and SGA are expected to remain at 50% and 10% of revenues for the foreseeable future. For simplicity, you are also asked to make the following assumptions: (a) depreciation is 15% of revenues; (b) it is safe to assume that capital expenditures will be approximately equal to depreciation; and, (c) Malicaca, Inc. will be able to manage with no changes in working capital.
You are also provided some detailed information about the Malicaca, Inc.’s main competitors and some market data. The business competitors have an average beta of equity of 2.50, and an average debt/equity ratio of 35% with an average beta of debt of 0.25. The risk free rate is 2.50% and the expected market risk premium (the difference between the market return and the risk free rate) is 4.00% for the foreseeable future. The tax rate is 34%. Suppose the equity beta of Malicaca, Inc. is equal to the beta assets in this business, its current debt/equity ratio is
Explanation / Answer
Revenues 500 $M COGS 50% of revenues SGA 10% of revenues Deprecaition 15% of revenues Competitors / Industry Beta of Equity 2.5 Beta of debt 0.25 Debt to equity 35% Risk free rate Rf 2.50% Risk Premium (Rm-Rf) 4% Cost of equity =rf + Beta of equity (Rm-Rf) Cost of debt =rf + Beta of debt (Rm-Rf) Cost of equity =2.5% + (2.5*4%) Cost of equity 12.50% Cost of Debt =2.5% + (0.25*4%) Cost of Debt 3.50% WACC = Weighted average cost of capital WACC = Cost of equity * % of equity + Effective Cost of debt * % of debt Effective Cost of debt = Cost of debt x (1-tax rate) Effective Cost of debt = 3.5%x (1-34%) Effective Cost of debt 2.31% Debt to equity 35% Debt = 0.35 E D+E =1, Solving D = 26%, E = 74% WACC = [12.5%*74%]+[2.31%*26%] WACC 9.85% Hence being in same industry Malicaca shall need to generate a minimum margin of 9.85% Revenues 500 $M COGS 250 $M SGA 50 $M Deprecaition 75 $M EBIT =500-250-50-75 $M EBIT 125 $M Now new capital infustion is equal to 75$M. Assume debt at 25% Debt 18.75 $M Interest =18.75*9.85% Interest 1.846875 $M EBT / PBT 123.153125 $M Tax @ 34% 41.8720625 $M PAT 81.2810625 $M Overall Margin = PAT/Sales 16.26% Considering the sales and margin, being greater than cost of equity, it can be deciphered that the firm may have a debt equity of 1.
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