PROBLEM 2 (14 points)

Corporacion is valuing Privado Co. as a potential acquisition target. Corporacions has debt for $200 million and equity for $1,300 million. The following is the result of a regression of returns of Corporacions equity against returns on the S&P 500 index:

rCorporacion = 0.03% + 2.2 rS&P500

Privado Co.'s target debt to equity ratio is 0.4 but its current debt is $80 million. At this target debt to equity level, the debt is risk-free. Privado Co. does not have any excess cash and will not have any excess cash in the future. Privado Co. is expected to generate a free cash flow of $20 million next year, and this free cash flow is expected to grow at a constant annual rate of g in perpetuity.

While Privado Co. is a private firm, there is a public firm, Public Inc., in a similar line of business as Privado Co. The following is the result of a regression of returns of Public Inc.s equity against returns on the S&P 500 index:

rPublic Inc. = 0.01% + 1.8 rS&P500

Public Inc.'s equity is currently worth $400 million; Public Inc.'s debt, which is risk-free, is currently worth $250 million; and Public Inc. has $170 million in excess cash. Assume a corporate tax rate of 0%, a risk-free rate of 3%, and a market risk premium of 6%.

a. Calculate Privado Co.s unlevered cost of capital (i.e., ru). [6 points] Show your work. b. Calculate Privado Co.s WACC [4 points] Show your work. c,. If Privado Co.s equity is estimated to be worth $320 million, calculate Privado Co.s free cash flow growth rate g. [4 points] Show your work.