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    Computing the Value of Operations

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    Bella Corp. is interested in acquiring Johnson Inc. Johnson has 1 million shares outstanding and a target capital structure consisting of 25% debt. Johnson's interest rate is 9.5%. Assume the risk free rate of interest is 5% and the market risk premium is 6%. Both companies have a 40% tax rate. Johnson's free cash flow is $4.5 million per year and is expected to grow at a constant rate of 2.5% a year. It's beta is 1.3. What is the value of Johnson's Operations?

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    Solution Summary

    This solution illustrates how to compute the cost of equity using the Capital Asset Pricing Model, the after-tax cost of debt given the nominal cost of debt, the weighted-average cost of capital given the target capital structure, and the value of operations.