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1. ABC Incorporated shares are currently trading for $30 per share. The firm has 1.4 billion shares
outstanding. In addition, the market value of the firm’s outstanding debt is $2.3 billion. The 10-year
Treasury bond rate is 6.45%. ABC has an outstanding credit record and has earned an AAA rating
from the major credit rating agencies. The current interest rate on AAA corporate bonds is 6.75%. The
historical risk premium for stocks over the risk-free rate of return is 5.2 percentage points. The firm’s
beta is estimated to be 1.2 and its marginal tax rate, including federal, state, and local taxes is 40%.
2 No Growth Incorporated had operating income before interest and taxes in 2011 of $250 million. The
firm was expected to generate this level of operating income indefinitely. The firm had depreciation
expense of $12 million that same year. Capital spending totaled $15 million during 2011. At the end of
2010 and 2011, working capital totaled $60 and $70 million, respectively. The firm’s combined marginal
state, local, and federal tax rate was 40% and its debt outstanding had a market value of $1.5 billion. The
10-year Treasury bond rate is 5.5% and the borrowing rate for companies exhibiting levels of
creditworthiness similar to No Growth is 8%. The historical risk premium for stocks over the risk free
rate of return is 5.2%. No Growth’s beta was estimated to be 1.2. The firm had 2,500,000 common
shares outstanding at the end of 2011. No Growth’s target debt to total capital ratio is 35%.
a. Free cash flow to the firm in 2011 = 250x (1-.4) + 12–15 – (70-60) = 150 + 10 –20 –10 = $130 million
b. Cost of Capital (COE) = 5.5 + 1.0(.052) = 5.552
c. WACC = .6 x .552 + .08 x (1-.4) x .35 = 0.4112x0.21=0.0863
d. PV = 130,000,000/.0863 = 1506373117.03
e. Equity Value = $1,506.03 - $1,300.0 = $206.3 million
Equity value per share = 206.3/2.5 = $82.52
3 The following information is available for two different common stocks: company A and Company B.
Company A Company B
Free cash flow per share $1.30 $6.00
in the current year
Growth rate in cash flow 10% 3%
per share
Beta 1.5 .7
Risk-free return 6.5% 6.5%
Expected return on all 14.5% 14.5%
stocks
4 Financial Corporation wants to acquire Great Western Inc. Financial has estimated the enterprise value
of Great Western at $110 million. The market value of Great Western’s long-term debt is $20 million,
and cash balances in excess of the firm’s normal working capital requirements are $5 million.
Financial estimates the present value of certain licenses that Great Western is not currently using to be
$5 million. Great Western is the defendant in several outstanding lawsuits. Financial Corporation’s
legal department estimates the potential future cost of this litigation to be $4 million, with an estimated
present value of $3.0 million. Great Western has 4 million common shares outstanding. What is the
value of Great Western per common share?