Reference no: EM132743577
It is December 2020. You are analyzing YKNOT Inc., a company headquartered in Waukesha, WI, which is manufacturing sailing ropes. You look at managerial projections of earnings, and in 2021, the company is expected to produce EBIT of $18M. In the same projections for 2021, you discover that the depreciation and amortization expenses of $2.5M are expected. And in the same projections, the company expects to invest $3M in property, plant, and equipment in that year. Additionally, the company expects to invest an additional $300,000 into Net Working Capital in that year. They do not expect to sell any equipment currently in place. The owners ask you to value the firm and the firm's equity. You decide to use Discounted Cash Flow methodology to do that. To provide a better estimate, you decide to use both WACC and APV methods. Clearly, you need some additional information for that. You ask managers about their debt policy. They tell you that the company currently has about $35M of bank loans, on which the company pays an average interest rate of 3% per year. But managers also tell you that they try to maintain the proportion of debt financing at 20% of total capital, which is an industry's average. Managers say that 2021 is expected to be very representative of the future. In the future, they expect the firm's free cash flow to grow at 2% per year forever. You perform some research and discover that the beta of firms similar to and operating in the YKNOW's industry is around 1.5. As a finance professional, you know that the current rate on U.S. Treasury 10-year bonds is 1% per year, considered risk-free, the prevailing market risk premium is 5%, and the marginal Federal tax rate on U.S. corporations is 21%.
a. Please calculate the weighted average cost of capital (WACC) of the firm.
b. Using WACC, calculate firm value using discounted cash flow approach.
c. Using firm value obtained in b, calculate the value of the firm's equity
d. Calculate firm value using adjusted present value (APV) approach assuming 35M debt is held forever.
e. Using firm value obtained in d, calculate the value of the firm's equity.