Corporate finance Assignment
1. Calculate TRUST’s company after-tax WACC. The risk-free rate was 4.21%, the market risk premium was 6% and the company tax rate was 30%. The WACC should be rounded to four decimal places.
After-tax WACC = rD (1-Tc) D/V + rE E/V
rE = rf + βequity(rm – rf) rE = 0.0421 + 0.81(0.06) rE = 0.0907
E = number of outstanding shares x current share price
E = 60 million x $3.43
E = $205.8 million
D = $44 million bank loans + $1.2 million short-term hire purchase commitments
D = $45.2 million
V = $205.8 million + $45.2 million
V = $251 million
After-tax WACC = (1-0.3)(0.0348 x 44/251 + 0.0618 x 1.2/251) + 0.0907 x 205.8/251
After-tax WACC = 0.0789
Calculate the RV Division WACC using Stephens’s method in paragraph 20. rE = rf + βequity(rm – rf) rE = 0.0421 + 2.1(0.06) rE = 0.1681
Using TRUST’s debt-to-equity mix of 21%:
Pre-tax divisional WACC = 0.1442 = (rD x 0.21) + (0.1681 x 0.79)
From above: rD = 0.0543
After-tax divisional WACC = (1-0.3)(0.0543 x 0.21) + (0.1681 x 0.79)
After-tax divisional WACC = 0.1408
What could be deduced about the relative business risk of the RV Division compared to its industry competitors if the industry equity beta was 2.10?
Using industry equity beta to determine the cost of equity suggests that the RV Division’s equity risk is the same as that of the industry. This indicates that the difference in business risk between the RV Division and its industry competitors will stem from TRUST’s choice of capital structure, i.e. level of debt to equity.
If RV was financed completely by equity, the cost of equity is the cost of capital for RV. Using the industry beta to determine rE suggests that RV’s equity risk is the same as that of the industry. The variation in business risk between RV and its industry competitors thus stems from the introduction of debt into the capital structure. Year Forecast 1 2 3 4 5 6
Sales 22000 23210 24487 25344 26231 26755
Variable cost 13200 13926
After-tax WACC = rD (1-Tc) D/V + rE E/V
rE = rf + βequity(rm – rf) rE = 0.0421 + 0.81(0.06) rE = 0.0907
E = number of outstanding shares x current share price
E = 60 million x $3.43
E = $205.8 million
D = $44 million bank loans + $1.2 million short-term hire purchase commitments
D = $45.2 million
V = $205.8 million + $45.2 million
V = $251 million
After-tax WACC = (1-0.3)(0.0348 x 44/251 + 0.0618 x 1.2/251) + 0.0907 x 205.8/251
After-tax WACC = 0.0789
Calculate the RV Division WACC using Stephens’s method in paragraph 20. rE = rf + βequity(rm – rf) rE = 0.0421 + 2.1(0.06) rE = 0.1681
Using TRUST’s debt-to-equity mix of 21%:
Pre-tax divisional WACC = 0.1442 = (rD x 0.21) + (0.1681 x 0.79)
From above: rD = 0.0543
After-tax divisional WACC = (1-0.3)(0.0543 x 0.21) + (0.1681 x 0.79)
After-tax divisional WACC = 0.1408
What could be deduced about the relative business risk of the RV Division compared to its industry competitors if the industry equity beta was 2.10?
Using industry equity beta to determine the cost of equity suggests that the RV Division’s equity risk is the same as that of the industry. This indicates that the difference in business risk between the RV Division and its industry competitors will stem from TRUST’s choice of capital structure, i.e. level of debt to equity.
If RV was financed completely by equity, the cost of equity is the cost of capital for RV. Using the industry beta to determine rE suggests that RV’s equity risk is the same as that of the industry. The variation in business risk between RV and its industry competitors thus stems from the introduction of debt into the capital structure. Year Forecast 1 2 3 4 5 6
Sales 22000 23210 24487 25344 26231 26755
Variable cost 13200 13926