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WACC and Firm Value

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I am doing a case analysis on Tasman Company that deals with operating and financial leverage. I am stuck on two questions (attached) and need help. The first question I already calculated the WACC at each debt level. But how do I explain the relationship. Please help me in explaining the relationship between the company's value and WACC. For the second question I am lost. How would I go about getting the annual payments for Tasman's loan. What loan amount would I go by (the case does not say much other than it is a 25 yr term loan with annual payments including both interest and principal amortization)? Please help me with these problems. The company has two proposals Plan A and Plan B. For the 2nd question if you need additional info please let me know. I at least want to know how to set it up and what info I need to accomplish it. Thank you

1.) Calculate Tasman's weighted average cost of capital (WACC) at each debt level. Explain the relationship between the company's value and WACC.

2.) What are the annual payments of Tasman's loan? Calculate the first-year debt service coverage ratio. (EBIT/Interest expense + before tax principle repayment.) Given the industry average coverage ratio is 4x, analyze Tasman's risk.

Solution Preview

I have answered both the questions. In case you need any clarification please let me know.

1.) Calculate Tasman's weighted average cost of capital (WACC) at each debt level. Explain the relationship between the company's value and WACC.

The relationship between WACC and the company's value can be explained in terms of the risk that the company faces. Without debt the company has only business risk and the company value will reflect this risk. Addition of debt gives rise to financial risk ( the risk of meeting fixed financial obligations or face bankruptcy). This increase in risk leads to an increased return demanded by the equity holders. Initially since the amount of debt is less and the cost is lower than equity, the use of debt increases the value of the firm. As the amount of debt ...

Solution Summary

The solution explains how to calculate the WACC at different debt levels and its impact on firm value.

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