HW #4 Phone City (WACC)

Phone City, a manufacturer of smartphones, is planning to go public at the end of 2020. The purpose of the stock offering is to retire debt and liquefy the position of some of its original investors. Future growth will be financed by Phone Citys internally generated cash flow and the additional borrowing made possible by the expected increase in the company debt capacity. The company has put together the following projections:

($ millions)		2021	2022	2023	2024	2025
EBIT		29.8	30.12	31.1	33.0	36.0
Deprecation		5.8	7.6	9.2	10.2	11
Increase in DT		0.8	0.6	0.7	0.7	1
CAPEX		18.2	12.2	14.3	14.3	12
change in NWC		-0.8	-0.8	1	1.8	0

After 2025, EBIT is expected to grow at 7% per year, CAPEX will equal depreciation, and the change in deferred taxes and the change in NWC will net out to 0. Phone City currently has debt of $112 million, but its CEO negotiated retiring $53 million of high yield debt (averaging 10%-12%) with the proceeds of the equity issue and refinancing the remainder at 8%. Net debt is expected to be reduced to $59 million at the end of 2020/beginning of 2021. The CFO expects to keep the debt ratio at about 30% of enterprise value.

Their corporate tax rate is 40%. Cost of equity accounting for risk and small size is determined using a beta of 2.0, a Treasury yield of 4.5%, a market risk premium of 4.4%, and a micro-cap size premium of 3.9%. Phone City already has 10 million shares outstanding to its present owners and plans to issue 5 million new shares in the stock offering bringing total shares outstanding to 15 million. Underwriter fees are expected to be 5% of gross proceeds and additional issue expenses to amount to $600,000. Your job is to value Phone City as of the end of 2020. Estimate the value of the common equity. Calculate the current forward P/E multiple implied by your valuation at the end of 2020. Determine whether the proceeds from the stock offering will be sufficient to retire the $53 million of debt. For the sake of comparison between the WACC valuations and APV that will be found in later homework problems, use a WACC model here as the target debt ratio is assumed to be relatively constant at 30% going forward.