Question
Renee Dye currently owns a very successful privately held company that at this time has a small amount of debt. In fact, her D/V is
Renee Dye currently owns a very successful privately held company that at this time has a small amount of debt. In fact, her D/V is estimated to be 10%. The company provides personal portfolio advice to individual equity investors. The name of the company is Dye for InVestors - DyeVest. Renee currently believes DyeVest has a 11% overall cost of capital. She is thinking about doing an Initial Public Offering (IPO) because as a public firm she hopes to lower her overall cost of capital due to the liquidity benefits of being a publicly traded firm. Renee notes that there are two publicly traded firms that are very comparable to DyeVest. Those firms and each firm's estimated Beta, current debt to value statistic, and tax rate are given below:
FIRM BETA D/V TAX RATE Bentley's Bets Beta is 1.88, D/V is 0.20 and TAX rate is 30%
Ruskin's Returns beta is 1.50 D/V is 0.25 Tax rate is 25%
Please answer the following based upon the information given.
For your work you may assume that DyeVest will be taxed at a rate of 25%. By the way, Renee has carefully studied the financial world and believes the risk free rate, RF, is 2% and the expected return of the market, E(RM) is 7%.
a. Based upon the information here what is your estimate of the equity cost of capital for DyeVest after it becomes a publicly traded firm? Be sure to clearly show your work.
b. If Renee were to adjust the capital structure of DyeVest by adding more debt such that the firm's D/V would move to 20%, what would you estimate the company's equity cost of capital to be? Be sure to clearly show all your work.
c. If it is estimated that the bond investors would require a yield of 5% from DyeVest if it had a capital structure of D/V = 20%. What would you estimate to be the firm's Weighted Average Cost of Capital (WACC) at that capital structure?
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