It is December 2018. You are analyzing YKNOT Inc., a company headquartered in Waukesha, WI, which...

90.2K

Verified Solution

Question

Finance

It is December 2018. You are analyzing YKNOT Inc., a companyheadquartered in Waukesha, WI, which is manufacturing sailingropes. You look at managerial projections of earnings, and in 2019,the company is expected to produce EBITDA of $18M. In the sameprojections for 2019, you discover that the depreciation andamortization expenses of $2M are expected. And in the sameprojections, the company expects to invest $2.3M in property,plant, and equipment in that year. Additionally, the companyexpects to invest an additional $300,000 into Net Working Capitalin that year. They do not expect to sell any equipment currently inplace.
The owners ask you to value the firm and the firm’s equity. Youdecide to use Discounted Cash Flow methodology to do that. Toprovide a better estimate, you decide to use both WACC and APVmethods. Clearly, you need some additional information forthat.
You ask managers about their debt policy. They tell you that thecompany currently has about $30M of bank loans, on which thecompany pays an average interest rate of 5% per year. But managersalso tell you that they try to maintain the proportion of debtfinancing at 20% of total capital, which is an industry’s average.Managers say that 2019 is expected to be very representative of thefuture. In the future, they expect the firm’s free cash flow togrow at 3% per year forever.
You perform some research and discover that the asset beta offirms in the YKNOW’s industry is 1.5. As a finance professional,you know that the current rate on U.S. Treasury 10-year bonds is2.9% per year, considered risk-free, the prevailing market riskpremium is 5%, and the marginal Federal tax rate on U.S.corporations is 21%.
a.) Please calculate the weighted average cost of capital (WACC)of the firm.
b.) Using WACC, calculate firm value using discounted cash flowapproach.
c.) Using firm value obtained in b, calculate the value of thefirm’s equity.
d.) Calculate firm value using adjusted present value (APV)approach assuming 30M debt is held forever
e.) Using firm value obtained in d, calculate the value of thefirm’s equity.

Answer & Explanation Solved by verified expert

3.8 Ratings (359 Votes)

a Since asset beta of firms in the industry of YKNOT is 15 therefore we can take Asset beta of YKNOT Unlevered beta 15 Debt as percentage of capital DT 20 Equity as percentage of capital ET 1 D 1 20 80 So we get DE 2080 025 Levered Beta or Equity Beta Unlevered Beta 1 1tax rate DE 15 1 121 025 151 79 x 025 15 x 11975 179625 Cost of equity re Risk free rate Levered Beta x market risk premium 29 179625 x 5 29 898125 1188125 b Cost of debt interest rate on bank loan rd 5 WACC rd DT1tax See Answer

Get Answers to Unlimited Questions

Join us to gain access to millions of questions and expert answers. Enjoy exclusive benefits tailored just for you!

Membership Benefits:

Unlimited Question Access with detailed Answers
Zin AI - 3 Million Words
10 Dall-E 3 Images
20 Plot Generations
Conversation with Dialogue Memory
No Ads, Ever!
Access to Our Best AI Platform: Flex AI - Your personal assistant for all your inquiries!

Become a Member

Transcribed Image Text

It is December 2018. You are analyzing YKNOT Inc., a companyheadquartered in Waukesha, WI, which is manufacturing sailingropes. You look at managerial projections of earnings, and in 2019,the company is expected to produce EBITDA of $18M. In the sameprojections for 2019, you discover that the depreciation andamortization expenses of $2M are expected. And in the sameprojections, the company expects to invest $2.3M in property,plant, and equipment in that year. Additionally, the companyexpects to invest an additional $300,000 into Net Working Capitalin that year. They do not expect to sell any equipment currently inplace.The owners ask you to value the firm and the firm’s equity. Youdecide to use Discounted Cash Flow methodology to do that. Toprovide a better estimate, you decide to use both WACC and APVmethods. Clearly, you need some additional information forthat.You ask managers about their debt policy. They tell you that thecompany currently has about $30M of bank loans, on which thecompany pays an average interest rate of 5% per year. But managersalso tell you that they try to maintain the proportion of debtfinancing at 20% of total capital, which is an industry’s average.Managers say that 2019 is expected to be very representative of thefuture. In the future, they expect the firm’s free cash flow togrow at 3% per year forever.You perform some research and discover that the asset beta offirms in the YKNOW’s industry is 1.5. As a finance professional,you know that the current rate on U.S. Treasury 10-year bonds is2.9% per year, considered risk-free, the prevailing market riskpremium is 5%, and the marginal Federal tax rate on U.S.corporations is 21%.a.) Please calculate the weighted average cost of capital (WACC)of the firm.b.) Using WACC, calculate firm value using discounted cash flowapproach.c.) Using firm value obtained in b, calculate the value of thefirm’s equity.d.) Calculate firm value using adjusted present value (APV)approach assuming 30M debt is held forevere.) Using firm value obtained in d, calculate the value of thefirm’s equity.