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New
Rating
AA
A
BBB
BB
Interest
rate
4.850%
5.100%
8.500%
12%
and a steady cash flow that will continue indefinitely, but which shows no growth prospects.
The cost of the acquisition would b
3000 DEM million
Summary financials show the following (DEM million):
Revenues/year:
Operating costs:
EBIT
Interest on debt
Taxable income
Tax at
36%
After-tax profit
1000
400 This includes depreciation of
600
100
500
180
320
100
SAP AG
Solution:
In order to get the company's beta at different levels of debt, we have to first calculate the unlevered beta.
Current levered beta:
1.15
Current debt/equity (D/E) ratio = debt/(share price*shares outstanding):
2.42%
Current debt/capital (D/C) ratio = debt/(debt +share price*shares outstanding):
2.36%
The levered beta is found from: Betalev=Betaunlev(1+(1-tax rate)(D/E)
The current unlevered beta is Betaunlev=Betalev/(1+(1-tax rate)(D/E)) =
1.13
Value of
Additional
Equity
debt Remaining
0
82,659
10000
72,659
15000
67,659
20000
62,659
30000
52,659
Shares
(millions)
107.04
94.09
87.62
81.14
68.19
New
Rating
AAA
AA
A
BBB
BB
Interest Levered
rate
Beta
4.40%
1.15
4.85%
1.24
5.10%
1.29
8.50%
1.36
12.00%
1.52
Cost of
Equity
10.33%
10.81%
11.11%
11.46%
12.35%
After-tax
Cost of
Debt
2.44%
2.69%
2.83%
4.72%
6.66%
Cos t of Ca pita l
Now we can calculate, for different debt levels, the cost of equity, the cost of debt, and the WACC:
Cost of
Capital Leverage
10.14%
2%
10.14%
9.66%
14%
9.45%
20% 9.66%
9.71%
26%
10.20%
38%
2%
9.45%
10.20%
9.71%
9.45%
Leverage
14%
20% 26%
38%
Change in firm value is a perpetuity = CF/r = cost savings/discount rate = old firm value(Old cost of capital-New cost of capital)
Annual cost savings = = old firm value(Old cost of capital-New cost of capital)
584 DEM million
Permanent increase in firm value = Annual cost savings/cost of capital =
6,180 DEM million
Increase in stock price = increase in firm value/shares outstanding =
70.54 DEM
or
9.1%
To evaluate the proposed acquisition, we must find the FCFF (free cash flow to firm) and discount this at the cost of capital:
EBIT
Subtract tax
Add depreciation
FCFF
600
-267
100
433
1,272
4,584