Question 4 (20 marks) . You are trying to assess the value of Super Co., a troubled automobile parts supplies company. You have collected the following information: The company is expected to generate $48 million in after-tax operating income next year, on a book value capital invested of $800 million. . The firm is currently extremely over levered with a debt to capital ratio of 80%. The levered beta for the stock is 2.72 and the pre-tax cost of debt is 12%. The marginal tax rate is 40%, the risk-free rate is 4% and the market risk premium is 6%. You believe that a new management can turn the firm around by Restructuring the firm's financing mix, to make it 50% debt and 50% equity. That will reduce the pre-tax cost of debt to 8%. Improving the after-tax return on capital on both existing and new investments to 9%. (a) Assuming that the firm is in stable growth, growing 3% a year in perpetuity, estimate the value of the firm today. (9 marks) (b) Estimate the cost of capital, if new management is able to restructure the debt in the firm (lowering the debt to capital ratio to 50% and the pre-tax cost of debt to 8%). (7 marks) (c) Assuming that the firm will stay in stable growth, growing at 3% a year, even with new management, estimate the new value for the firm. (4 marks) Question 4 (20 marks) . You are trying to assess the value of Super Co., a troubled automobile parts supplies company. You have collected the following information: The company is expected to generate $48 million in after-tax operating income next year, on a book value capital invested of $800 million. . The firm is currently extremely over levered with a debt to capital ratio of 80%. The levered beta for the stock is 2.72 and the pre-tax cost of debt is 12%. The marginal tax rate is 40%, the risk-free rate is 4% and the market risk premium is 6%. You believe that a new management can turn the firm around by Restructuring the firm's financing mix, to make it 50% debt and 50% equity. That will reduce the pre-tax cost of debt to 8%. Improving the after-tax return on capital on both existing and new investments to 9%. (a) Assuming that the firm is in stable growth, growing 3% a year in perpetuity, estimate the value of the firm today. (9 marks) (b) Estimate the cost of capital, if new management is able to restructure the debt in the firm (lowering the debt to capital ratio to 50% and the pre-tax cost of debt to 8%). (7 marks) (c) Assuming that the firm will stay in stable growth, growing at 3% a year, even with new management, estimate the new value for the firm. (4 marks)
