question archive Nick Frost would like to value Automaton, Inc
Nick Frost would like to value Automaton, Inc
Subject:FinancePrice:4.87 Bought7
Nick Frost would like to value Automaton, Inc. using the discounted cash flow (DCF) method.
He forecasts Free Cash Flows (FCFs) of $135 million, $145 million, $146 million, respectively for years 1, 2, and 3. After year 3, he assumes FCFs will increase by 2 percent to perpetuity.
Nick gathers the information below (his "input variables") to compute Automaton's cost of equity, debt, and enterprise value.
Cost of Equity
Risk-Free-Rate = 3 percent
Beta = 1.03
Return of Market Portfolio (S&P 500) = 7 percent
Debt Financing
Debt to Equity Ratio = 45 percent
Market Value of Zero-Coupon Bonds = $100 million or 75 percent of par value
Maturity of Zero-Coupon Bonds = 15 years
Tax Rate = 35%
1. Based on Nick's input variables, what fraction of Automaton's assets are equity financed (i.e. Equity-to-Total capitalization ratio)?
A.
45%
B.
55%
C.
40%
D.
69%
2. Using the Gordon Growth Model, what is Automaton's Terminal Value? Assume a perpetual growth rate, "g," of 2 percent and WACC of 8.9 percent, and use Nick's FCF forecasts.
A.
$1673
B.
$1641
C.
$2116
D.
$2158
3. What is Automaton's Enterprise Value? Assume a WACC of 8.9% and constant growth rate of 2 percent to perpetuity and Nick's FCF forecasts.
A.
$2030
B.
$359
C.
$2584
D.
$1998
4. Based on Nick's input variables, what is Automaton's after-tax cost of debt?.
A.
0%
B.
-1.23%
C.
1.26%
D.
1.90%
5. Based on Nick's input variables, what is Automaton's Cost of Equity using CAPM?
A.
4.1%
B.
10%
C.
10.2%
D.
7.1%
Purchase A New Answer
Custom new solution created by our subject matter experts
GET A QUOTE
Answer Preview
Answers:
1. Correct option is D). 69%
2. Correct option is D). $2,158
3. Correct option is A). $2,030
4. Correct option is C). 1.26%
5. Correct option is D). 7.1%
Step-by-step explanation
Computation of the equity-to-total capitalization ratio:-
Debt-to-equity ratio = 45% or 0.45
Debt = 0.45
Equity = 1
Equity-to-total capitalization ratio = Value of equity / Total capital
= 1 / (1+0.45)
= 68.97% Or 69%
Computation of the Automaton's terminal value:-
Terminal value = (Cash flow in year 3*(1+Growth rate) / (WACC - Growth rate)
= ($146*(1+2%)) / (8.9%-2%)
= $148.92 / 6.2%
= $2,158.26 Or $2,158 million
We can calculate the pretax cost of debt by using the following formula in excel:-
=rate(nper,pmt,-pv,fv)
Here,
Rate = Pretax cost of debt
Nper = 15 periods
Pmt = 0
PV = $100*75% = $75 million
FV = $100 million
Substituting the values in formula:
=rate(15,0,-75,100)
= 1.94%
Computation of the Automaton's after tax cost of debt:-
After tax cost of debt = Pretax cost of debt * (1 - Tax rate)
= 1.94% * (1 - 35%)
= 1.26%
Computation of the Automaton's cost of equity:-
Cost of equity = Risk free rate + Beta * (Market return - Risk free rate)
= 3%+ 1.03*(7%-3%)
= 3% + (1.03 * 4%)
= 3% + 4.12%
= 7.12% Or 7.1%
PFA
