Reference no: EM133114740
You are the manager of a diversified firm with two divisions: consumer goods and finance. The consumer goods division accounts for approximately 50% of the firm's overall value. You want to estimate the (after-tax) weighted average cost of capital for the finance division as well as for the overall firm. Your firm operates with a 40% D/V ratio overall and borrows at Rd = 4%. Your finance division operates with a 35% D/V ratio and also borrows at Rd = 4%. You have already estimated that the consumer goods division has an asset beta (Ba) of 1.1.
You have found a publicly traded comparable firm called Fintech Inc to help you estimate a beta for the finance division. Fintech has an equity beta (Be) of 0.9. It has 2M shares outstanding with a current market price of $25 per share. It also has public bonds outstanding with a total face value of $50M, a stated annual interest rate of 8% (paid semi-annually), and 10 years to maturity. Public bonds with the same credit rating as Fintech have a current average Bond-Equivalent Yield of 6%. Fintech does not have any other debt outstanding.
The current risk-free rate is 2% and the expected market risk premium is 6%. All firms pay a 25% tax rate.
a. What is your estimate of the current value of Fintech, Inc's public bonds?
b. What is your estimate of Fintech, Inc's asset beta (Ba)?
c. What is your estimate of the appropriate equity beta (Be) for the finance division?
d. What is your estimate of the finance division's (after-tax) Weighted Average Cost of Capital?
e. What is your estimate of your firm's overall asset beta (Ba) and its equity beta (Be)?
f. What is your estimate of your firm's (after-tax) Weighted Average Cost of Capital?
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