Get The Beta Of Equity From
Get the beta of equity from the two comparable companies Orange and Tomy by estimating regression of returns on the market return.
Unlever these equity beta using the actual capital structure of these companies to get their asset beta
Take the equally- or value-weighted average of asset beta across the two comparable companies
The case state that the upgrade will increase risk by 50%
Take asset beta estimated in the question above, and increase it by 50%
Estimate the market historical return using the return series provided in the excel file
Take the 30 years Swiss government bond rate as the risk free rate
Use CAPM with the asset beta computed above
Company has no debt, but assuming that interest is tax deductible in Switzerland, the companies can increase value by borrowing, and lowers its tax bill, by shielding CF from taxation
Important that the student mention the assumption of tax deductibility in Switzerland
Look at the leverage ratio of the comparable firms and take that as the target leverage
Three assumptions
Tax is the only imperfection (MMII theory assumption)The assets of the comparable companies have the same risk as the asset to be evaluated here We are going to maintain and implement a constant debt-to-equity ratio
If the PV of the upgrade is X, we need to know the target capital structure. Assume 0.5. Then we have to issue 0.5*X in new debt to maintain a constant debt to equity ratio
Valuation in two parts
Value CF using the pretax WACC=COC computed above (50% riskier)
Determine the financing plan. We need to assume a cost of debt, say Rd
Compute the tax shied for every period based on debt outstanding and Rd
Tax shield=debt*rd*tax rate/(1+rd)^n
Discount tax shield at Rd (or COC) and add to PV of CF
Assume an initial capital structure of 0.5, debt in year 0 is 0.5*X
Debt in year 1 is still 0.5*X
Debt in year2 is 0.5*X/2
Debt after is zero The company will have the project value and tax shield value, but decrease the value of debt.
Unlever these equity beta using the actual capital structure of these companies to get their asset beta
Take the equally- or value-weighted average of asset beta across the two comparable companies
The case state that the upgrade will increase risk by 50%
Take asset beta estimated in the question above, and increase it by 50%
Estimate the market historical return using the return series provided in the excel file
Take the 30 years Swiss government bond rate as the risk free rate
Use CAPM with the asset beta computed above
Company has no debt, but assuming that interest is tax deductible in Switzerland, the companies can increase value by borrowing, and lowers its tax bill, by shielding CF from taxation
Important that the student mention the assumption of tax deductibility in Switzerland
Look at the leverage ratio of the comparable firms and take that as the target leverage
Three assumptions
Tax is the only imperfection (MMII theory assumption)The assets of the comparable companies have the same risk as the asset to be evaluated here We are going to maintain and implement a constant debt-to-equity ratio
If the PV of the upgrade is X, we need to know the target capital structure. Assume 0.5. Then we have to issue 0.5*X in new debt to maintain a constant debt to equity ratio
Valuation in two parts
Value CF using the pretax WACC=COC computed above (50% riskier)
Determine the financing plan. We need to assume a cost of debt, say Rd
Compute the tax shied for every period based on debt outstanding and Rd
Tax shield=debt*rd*tax rate/(1+rd)^n
Discount tax shield at Rd (or COC) and add to PV of CF
Assume an initial capital structure of 0.5, debt in year 0 is 0.5*X
Debt in year 1 is still 0.5*X
Debt in year2 is 0.5*X/2
Debt after is zero The company will have the project value and tax shield value, but decrease the value of debt.