Problem 2 Aramco, known as the most profitable company in the world, is a petroleum and natural gas company privately owned by the Saudi Arabia government The possibility of Aramco going public has attracted a lot of market attention, and you want to estimate its market value of equity Aramcos current D E ratio is 1 9, and it plans to keep this ratio fixed Aramcos long term bonds are traded at a YTM of 3 8 You determined that Aramcos operating risk characteristics are comparable to those of shell, whose cost of debt and equity are 4 5 and 10 2 , respectively Shells D E ratio is , which is expected to remain stable Shell has an EV EBIT ratio of 20 Aramcos corporate tax rate is 25 (All the other M M assumptions hold ) Suppose that you forecasted Aramcos free cash flows for the next three years as follows Year 1 Year 2 Year 3 Free Cash Flow $87 44B $96 77B $104 55B Terminal value You need to estimate the terminal value at year 3 using the exit multiple approach If Aramcos EBIT at year 3 is expected to be $95 25B and Shell has an EV EBIT ratio of 20, what is the terminal value What is shells unlevered cost of capital What would be Aramcos unlevered cost of capital What is Aramcos cost of debt What would be Aramcos cost of equity What is Aramcos cost of capital (i e WACC) Which one is larger between Aramcos cost of capital vs Aramcos unlevered cost of capital Explain why this is generally the case Which one is larger between Aramcos unlevered cost o capital vs Aramcos cost of equity Explain why this is generally the case What is Aramcos enterprise value What would be the expected value of Aramcos market equity once it goes public Aramco plans to start a new project which has an identical operating risk characteristics compared to Aramcos existing projects, it differs in terms of financing structure At time 0, this project will be partially financed with a 1 year maturity debt so that D E ratio equals to 3 After the debt matures at year 1, Aramco will not issue any more debt for this project so that it will be completely financed with equity from year 1 Is it appropriate to discount the projects free cash flows using Aramcos WACC Explain your answer ( no computation is needed here)

The Answer is in the image, click to view ...

Answered step by step

Verified Expert Solution

Link Copied!

Question

1 Approved Answer

Posted on Sep 07, 2024

Problem 2 Aramco, known as the most profitable company in the world, is a petroleum and natural gas company privately owned by the Saudi Arabia

Problem 2

Aramco, known as the most profitable company in the world, is a petroleum and natural gas company privately owned by the Saudi Arabia government. The possibility of Aramco going public has attracted a lot of market attention, and you want to estimate its market value of equity.

Aramcos current D/E ratio is 1/9, and it plans to keep this ratio fixed. Aramcos long-term bonds are traded at a YTM of 3.8%.
You determined that Aramcos operating risk characteristics are comparable to those of shell, whose cost of debt and equity are 4.5% and 10.2%, respectively. Shells D/E ratio is , which is expected to remain stable. Shell has an EV/EBIT ratio of 20.
Aramcos corporate tax rate is 25%. (All the other M&M assumptions hold.)

Suppose that you forecasted Aramcos free cash flows for the next three years as follows:

	Year 1	Year 2	Year 3
Free Cash Flow	$87.44B	$96.77B	$104.55B
Terminal value			???

You need to estimate the terminal value at year 3 using the exit multiple approach. If Aramcos EBIT at year 3 is expected to be $95.25B and Shell has an EV/EBIT ratio of 20, what is the terminal value?
What is shells unlevered cost of capital? What would be Aramcos unlevered cost of capital?
What is Aramcos cost of debt? What would be Aramcos cost of equity?
What is Aramcos cost of capital (i.e. WACC)?
Which one is larger between Aramcos cost of capital vs. Aramcos unlevered cost of capital? Explain why this is generally the case.
Which one is larger between Aramcos unlevered cost o capital vs. Aramcos cost of equity? Explain why this is generally the case.
What is Aramcos enterprise value?
What would be the expected value of Aramcos market equity once it goes public?
Aramco plans to start a new project which has an identical operating risk characteristics compared to Aramcos existing projects, it differs in terms of financing structure:

At time 0, this project will be partially financed with a 1-year maturity debt so that D/E ratio equals to 3.
After the debt matures at year 1, Aramco will not issue any more debt for this project so that it will be completely financed with equity from year 1.

Is it appropriate to discount the projects free cash flows using Aramcos WACC? Explain your answer ( no computation is needed here)