Estimate the cost of capital for the division

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Reference no: EM13876210

In the face of disappointing earnings results and increasingly assertive institutional stockholders, Eastman Kodak considered a major restructuring in 1993. As part of this restructuring, it considered the sale of its health division, which earned $560 million in earnings before interest and taxes in 1993, on revenues of $5.285 billion. The growth in earnings was expected to diminish to 6% between 1994 and 1998 and to 4% thereafter. Capital expenditures in the health division amounted to $420 million in 1993, whereas depreciation was $350 million. Both were expected to grow 4% a year from 1994 onwards. Working capital requirements are negligible. The average beta of firms competing with Eastman Kodak’s health division is 1.15. Although Eastman Kodak has a debt ratio (D/(D+E)) of 50%, the health division can sustain a debt ratio (D/(D+E)) of only 20%, which is similar to the average debt ratio of firms competing in the health sector. At this level of debt, the health division can expect to pay 7.5% on its debt, before taxes. The tax rate is 40%, the Treasury bond rate is 7%, and market risk premium is 5.5%.

(a) Estimate the (after-tax) cost of capital (WACC) for the division.

(b) Estimate the value of the division as at the end of 1993.

Reference no: EM13876210

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