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# Free cash flow, cost of equity and WACC

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Problem
The following are the information on the income statements of an Oil firm, for 2007 and 2008 (all dollar figures are in millions):
2007
Sales: \$12,200.00, cost of goods sold: 72% of sales, depreciation: \$850.00, additional CAPEX: \$900.00, additional investment in net working capital: \$150.00
2008
Sales: \$14,500.00, cost of goods sold: 78% of sales, depreciation: \$970.00, additional CAPEX: \$1,200.00, additional investment in net working capital: \$200.00
Applicable tax rate for the company is 38%.
a. Calculate free cash flows (FCF) for 2007 and 2008
b. Estimate FCF for 2009-2013 using the following assumptions: Company's sales will grow at 15% per year over the next five years, cost of goods sold is expected to increase by 2% each year from its 2008 level, CAPEX is expected to be additional 10% of additional sales per year, additional net working capital per year will be equal to 5% of additional sales, depreciation expenses will equal to the prior year total plus 10% additional CAPEX of each year. Since the company is a going concern we need not be concerned about the liquidation value of the firm's assets at the end of 2013.

Problem
A Manufacturing Company's current capital structure is comprised of 40% debt and 60% equity (based on market values). Its equity beta (based on its current level o debt financing) is 1.4 and its debt beta is 0.32. Also, the risk free rate of interest is currently 3.5% on long-term government bonds. Its cost of debt is 8%. The company's investment banker advised the firm that, according to its estimates, the market risk premium is 6.5%.
1- What is your estimate of the cost of equity capital for this company (based on the CAPM)?
2- If the firm's marginal tax rate is 35%, what is the firm's overall weighted average cost of capital?
3- In addition, the firm is considering a major expansion of its current business operations. The firm's investment banker estimates that it will be able to borrow to 40% of the needed funds and maintain its current credit rating and borrowing cost. Estimate the WACC for the project.

https://brainmass.com/economics/finance/free-cash-flow-cost-of-equity-and-wacc-275967

#### Solution Summary

The solution explains some problems relating to calculation of free cash flow, cost of equity and WACC

\$2.19

## Financial management: required return, beta, terminal value, WACC, project selection

8-16
You have been managing a 5 million portfolio that has a beta of 1.25 and a required rate of return of 12%. the current risk free rate is 5.25%. assume that you receive another 500,000. If you invest the money in a stock with a beta of 0.75, what will be the required return on your 5.5 million portfolio?

9-15
Dozier Corporation is a fast growing supplier of office products. Analysts project the following free cash flows (FCFs) during the enxt 3 years, after which FCF is expected to grow to a constant 7% rate. Dozier's WACC is 13%.

Year: 0=NA Year 1= -20Millon Year 2= 30 Million Year 3= 40 Million

a. What is Dozier's terminal, or horizon, value? (hint. find the value of all free cash flows beyond year 3 discounted back to year 3)?
b. What is the firms value today?
c. Suppose dozier has 100 Million of debt and 10 Million shares of stock outstanding. What is your estimate of the current price per share?

10-9
The Patrick company's cost of common equity is 16%, its before tax cost of debtr is 13%, and its marginal tax rate is 40%. The stock sells at book value. using the following balance sheet, calculate Patricks WACC.

Assets:
cash=120
acct receivables=240
inventories=360
plant and equip net=2,160
total assets=2,880

Liabilities and Equity
long-term debt=1,152
common equity=1,728
total liabilities and equity=2,880

10-12
WACC. Midwest electric company MEC uses only debt and common equity. It can borrow unlimited amounts at an interest rate of rd=10% as long as it finances at its target capital structure, which calls for 45% debt and 55% common equity. Its last dividend was \$2, its expected constant growth rate is 4%, and its common stock sells for \$20. MEC tx rate is 40%. Two projects are available: Project A has a rate of return of 13%, while Project B's return is 10%. These two projects are equallly risky and about as risky as the firms existing needs.

a. What is the cost of common equity?
b. What is the WACC?
c. Which Project should Midwest accept?

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