Question
Fat Burger is a privately held fast food chain about to go public by issuing 200 million shares. The CFO decided that the firm should
Fat Burger is a privately held fast food chain about to go public by issuing 200 million shares. The CFO decided that the firm should remain debt-free after going public. Cash flow from assets (CFFA), is expected to be a perpetual $350 mil per year. Fat Burgers tax rate = 34%.
Burger Shack is publicly-traded comparable company with an equity beta = 1.15, debt beta = 0.15 and a D/E = 0.5, and a tax rate = 30%. Risk-free rate = 3.5%; market risk premium = 5.5%. (15 pts)
a. What is Fat Burgers cost of equity capital? State any necessary assumptions. (4pts)
b. What is Fat Burgers value and IPO share price? (2 pts)
c. Prior to Fat Burgers IPO, you convince the CFO that the optimal capital structure is D/E = 1/3. Fat Burgers cost of debt = 4.6% and beta debt = 0.2. Based on this information, what is Fat Burgers i) levered equity beta; ii) cost of equity capital; and iii) WACC assuming interest expense is tax deductible? Hint: If D/E = 1/3, then the weights of debt & equity are 25% & 75% respectively. (5 pts) d. Using the WACC in part (c), what is Fat Burgers total value (VL), value of debt & equity? Hint: must first calculate PV of CFFA. You will also need Vu from part (b). (2 pts) e. Youre a founding principal of Fat Burger, would you prefer the 0.33 D/E target or all equity? Why or why not? State any assumptions that are needed to support your answer. (2 pts)
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