ABC is a mature company with no real growth expectation. Its estimated annual re

Question

ABC is a mature company with no real growth expectation. Its estimated annual revenue for X1 is 100, its EBITDA margin is 60%, and the tax rate on profit the company has been paying is 34%, which the ratio (Working Capital Need / Net Revenue Need) is 10%. Additionally its debt is 100 and its actual Kd (cost of capital of others) is 10%. Your actual Ke (Cost of Capital employed) is 15%. Assuming CAPEX equals depreciation at maturity, calculate E0 (Equiy value at date 0) and V0 (Company Value at date zero) using the Free Cash Flow to Firm (FCFF) and Free Cash Flow to Equity ( FCFE).

Explanation / Answer

Cost of debt(Kd) = Interest / value of debt

Cost of Capital employed ( Ke) = Cash flow for Firm / value of firm.

Company value ( V0 ) = Value of debt + value of equity.

In the given question ,

Working Capital Need / Net Revenue Need = 10%

=> Working capital = 10% * Net Revenue Need.

CAPEX equals depreciation at maturity . it means no addition Capital expenditure used .

Revenue = 100

EBITDA = 60% of 100 = 60

Interest of debt = Value of debt * Kd = 100* 10% = 10.

Now ,

Using the concept of Ke = 34.7/ V => V = 34.7/ 15% = 231.33

Value of equity = Value of firm - value of debt

= 231.33 - 100 = 131.33.

Note : The answer is true based on the terms and figure given in question , as generally Ke is notation used for cost of Equity ----- not for whole capital employed......

EBITDA 60 Interest -10 EBT(net revenue) 50 Additional working capital -5 45 Tax -15.3 EAT (cash flow to firm) 34.7

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