Question
Santa Fe Pacific, a major rail operator with diversified operations, had EBITDA (earnings before interest, tax, and depreciation) of $637 million in 1993. Depreciation and
Santa Fe Pacific, a major rail operator with diversified operations, had EBITDA (earnings before interest, tax, and depreciation) of $637 million in 1993. Depreciation and capital expenditure are the same amount of $235 million. The firm is in steady state and its EBITDA is expected to grow at 3% per year in perpetuity while capital expenditure continues to offset by depreciation.
Other financial information is as follows:
Book value of Debt = $1.34 billion (A rate with yield-to-maturity of 7.43% trading at par value)
Debt-to-Capital Ratio = 28.63%
Beta of equity = 1.25
The number of shares outstanding = 183.1 million shares
Current stock price = $18.25
Tax rate is 40%
Santa Fe’s working capital is negligible. T-bond rate is 7% and the risk premium is 5.5%.
Now Santa Fe is planning to restructure its debt by reducing debt-to-capital ratio to 20%. Expected bond rating and the cost of debt at this debt ratio are A+ and 6.93%, respectively. The probability of default at this planned debt ratio is estimated to be 10% and that the cost of bankruptcy is estimated to be 20% of unlevered firm value, estimate the value of firm with the APV approach.
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