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DLR Company: APV or WACC to calculate market value of equity

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DLR Company has just announced its results for the end of fiscal year. The following information is from its financial statements (all numbers in $ 000):

Income Statement
Sales 20,000.00
Cost of goods sold (14,000.00)
Gross profi t 6,000.00
SG&A Expenses (2,000.00)
Depreciation (1,600.00)
Operating income 2,400.00
Interest expense (400.00)
Earnings before tax 2,000.00
Taxes (700.00)
Net income 1,300

Balance Sheet
Current Assets 4,000 Interest bearing debt 5,000
Fixed Assets 8,000 Shareholders Equity 7,000
Total Assets 12,000 Total Liability & Equity 12,000

DLR's business is stable (its expected future growth rate is zero), its capital expenditures are currently equal to the depreciation and this situation will continue in the future. The net working capital needs will also remain unchanged. The company pays 35% tax, its cost of debt is 8% and the company plans to keep the same amount of debt indefinitely. If DLR didn't have debt, its cost of equity would have been 12%. The current interest rate on government T-bonds is 3.5% and the market risk premium is 7.5%.

a. Given the information available, what approach (APV or WACC) is better to use to calculate the market value of equity? Why?
b. What is the market value of company's equity?
c. What is the value of interest tax shield?
d. What is the company's WACC?
e. What are the company's levered cost of equity and beta?


Solution Summary

APV and WACC to calculate market value of equity is examined.