Reference no: EM13304177

Capital Budgeting

All figures are in millions unless otherwise stated

A corporation is selling ABC company is to be sold.

ABC's capital structure is 35% debt and 65% equity. Market value of capital is $6,300.0. The firm's current cost of debt is 3.57% and cost of equity is 8.29%. The risk free rate is 2.25%, beta is 1.22, and the company's tax rate is 42% including state and local taxes. Financial data is calculated using straight-line depreciation. ABC accounts for 44% of capital usage (of $6,300).

The deal structure includes the assumption of a $500.0 bond issue that matures in 2018, with a stated coupon rate of 5.5% and a current yield of 3.45%. It is anticipated the equity issue will be 100.0 shares.

ABC division generated sales of $950.0 this year and these are expected to grow at a 3.0% rate for the foreseeable future, ceteris paribus. Cost of goods sold has been steady at 68% of sales, and selling, general, and administrative expenses are expected to be about 12% of sales.
The sale will include transfer of the existing lease on the plant, which has 15 years remaining, and scheduled payments of $1.75 per year.

ABC also has patents with the following expected values and lives:

ABC Patents
2011 Book Value Remaining life (years)
Device A 250.00 7
Device B 175.00 9
Device C 340.00 10
Device D 125 .00 14
Device E 600.00 18

a. Find the current value of the ABC division based a 15 year time horizon and on the information above. You do not have to calculate a terminal value for the company in this step - just the present value of the 15 years.

b. ABC will need additional office space for housing administrative staff. Needs are projected to cost $260.00 thousand in 2012 and rents are increasing by 1.5% per year in this community. What impact will this have on the current value? What is the current value?

c. ABC expects to launch a new product in 2013 that will generate sales of $80.00 in the first year, with expected growth of 6% for the next 3 years, 4% for 2 years after that, and then 2% per year after that. What is the current value now? (Assume all of the above points remain the same)

d. Would it make sense to sell the company for this amount?

e. If you assumed ABC would grow at 2% per year after the initial 15 years, what would be the terminal value of the company in 2026? What would be the price per share after accounting for all of the above?

f. What is the expected Economic Value Added of ABC in 2012 assuming no additional capital investments?