Question 2 Estimating the WACC Based on Comparable Firms You are trying to assess the cost of capital for a small commercial aircraft manufacturer called Jetstream Inc. Unfortunately, Jetstream is a private company so you can not estimate its equity beta using its stock returns. You have, however, collected some information on comparable firms that are publicly traded (see the table below). Assume that Jetstream targets a stable debt to enterprise value ratio (D/(D+E)) of 10% and that its cost of debt is 3.95%. All firms face a marginal tax rate of 21%, the market risk premium (E[rm]-re) is 5%, and the risk-free rate (rf) is 3.5%. Additionally, assume that corporate taxes are the only market imperfection. re ru Lightwing Aircraft Inc. Gulfstream Jets Into Thin Air Corp Turbulence Corp. D/D+E) 50% 45% 15% 55% rp 4.85% 4.80% 4.00% 4.87% BE 1.8 1.75 1.3 1.89 A) Using the CAPM calculate the cost of equity for each competing firm. Then, using the Modigliani and Miller formula calculate the unlevered cost of capital for each competing firm. Tabulate your results in a table similar to the one above. B) Assume that the unlevered cost of capital of Jetstream Inc. is equal to the average unlevered cost of capital of the competing firms, what is Jetstream's cost of equity? C) What is Jetstream's WACC? Question 2 Estimating the WACC Based on Comparable Firms You are trying to assess the cost of capital for a small commercial aircraft manufacturer called Jetstream Inc. Unfortunately, Jetstream is a private company so you can not estimate its equity beta using its stock returns. You have, however, collected some information on comparable firms that are publicly traded (see the table below). Assume that Jetstream targets a stable debt to enterprise value ratio (D/(D+E)) of 10% and that its cost of debt is 3.95%. All firms face a marginal tax rate of 21%, the market risk premium (E[rm]-re) is 5%, and the risk-free rate (rf) is 3.5%. Additionally, assume that corporate taxes are the only market imperfection. re ru Lightwing Aircraft Inc. Gulfstream Jets Into Thin Air Corp Turbulence Corp. D/D+E) 50% 45% 15% 55% rp 4.85% 4.80% 4.00% 4.87% BE 1.8 1.75 1.3 1.89 A) Using the CAPM calculate the cost of equity for each competing firm. Then, using the Modigliani and Miller formula calculate the unlevered cost of capital for each competing firm. Tabulate your results in a table similar to the one above. B) Assume that the unlevered cost of capital of Jetstream Inc. is equal to the average unlevered cost of capital of the competing firms, what is Jetstream's cost of equity? C) What is Jetstream's WACC
