Your friend is looking to launch a new hotel chain, Roxy Inc., designed to serve the traveling needs of the budget-minded millennial traveler. To launch Roxy Inc., she is expected to invest $500 million this year (year=0). The hotel chain is expected to generate free cash flows of $27 million per year, starting in year 1. Thereafter, these free cash-flows are expected to grow at 3 percent per year in perpetuity. For simplicity, assume these cash-flows are received at the end of each year. Your friend knows you've been taking this class, so she asked you to assess the potential value of the new hotel chain. To help you, she gives you the following reports for a handful of publicly-traded firms, as well as the expected returns on the government bond (Treasury), and the risk premium on the value-weighted market portfolio: Market Market Value of Value of Equity Company Equity Debt Beta Dropbox 900 150 2 Ikea 1,000 100 2.3 Intercontinental Hotels Group 7,500 2,500 1.6 10-year Treasury rate Expected Market Risk Premium 2.0% 5.0% Assume throughout that the CAPM holds for all assets, and that the debt of Dropbox, Ikea, and Intercontinental Hotel Group is risk-free. None of these firms hold (excess) cash assets. (a) If Roxy Inc. were to be 100% equity financed, what would be a reasonable estimate of the expected return on Roxy's equity? What is Roxy's WACC? [10 marks] The expected return on equity is: Roxy's WACC is: [SHOW YOUR WORKING] (b) What is the value of Roxy Inc.? Is the project worth pursuing? [10 marks] The estimated value of Roxy Inc. is: The estimated gain to your friend from investing in Roxy's Inc. is: Is the investment worth pursuing (Yes/No). [SHOW YOUR WORKING] (c) Assume now that the new hotel chain is financed instead with a debt-to-value ratio of 25%, and that this leverage ratio is not expected to change over time. What is Roxy's WACC? What is its cost of equity? What is the value of Roxy? In this part, assume that the debt issued is risk-free and that there are no frictions in financial markets (no taxes, bankruptcy costs, etc). [10 marks] Roxy's WACC with leverage is: Roxy's return on equity: The value of Roxy Inc. is now: Is the investment worth pursuing (Yes/No). [SHOW YOUR WORKING] (d) After you complete your analysis in part (C), you learn that Roxy does actually pay a corporate tax of 35%. Describe the effect of corporate taxes on (i) Roxy's WACC and (ii) Roxy's expected value. [10 marks] Roxy's WACC is: Roxy's value is: [SHOW YOUR WORKING] Your friend is looking to launch a new hotel chain, Roxy Inc., designed to serve the traveling needs of the budget-minded millennial traveler. To launch Roxy Inc., she is expected to invest $500 million this year (year=0). The hotel chain is expected to generate free cash flows of $27 million per year, starting in year 1. Thereafter, these free cash-flows are expected to grow at 3 percent per year in perpetuity. For simplicity, assume these cash-flows are received at the end of each year. Your friend knows you've been taking this class, so she asked you to assess the potential value of the new hotel chain. To help you, she gives you the following reports for a handful of publicly-traded firms, as well as the expected returns on the government bond (Treasury), and the risk premium on the value-weighted market portfolio: Market Market Value of Value of Equity Company Equity Debt Beta Dropbox 900 150 2 Ikea 1,000 100 2.3 Intercontinental Hotels Group 7,500 2,500 1.6 10-year Treasury rate Expected Market Risk Premium 2.0% 5.0% Assume throughout that the CAPM holds for all assets, and that the debt of Dropbox, Ikea, and Intercontinental Hotel Group is risk-free. None of these firms hold (excess) cash assets. (a) If Roxy Inc. were to be 100% equity financed, what would be a reasonable estimate of the expected return on Roxy's equity? What is Roxy's WACC? [10 marks] The expected return on equity is: Roxy's WACC is: [SHOW YOUR WORKING] (b) What is the value of Roxy Inc.? Is the project worth pursuing? [10 marks] The estimated value of Roxy Inc. is: The estimated gain to your friend from investing in Roxy's Inc. is: Is the investment worth pursuing (Yes/No). [SHOW YOUR WORKING] (c) Assume now that the new hotel chain is financed instead with a debt-to-value ratio of 25%, and that this leverage ratio is not expected to change over time. What is Roxy's WACC? What is its cost of equity? What is the value of Roxy? In this part, assume that the debt issued is risk-free and that there are no frictions in financial markets (no taxes, bankruptcy costs, etc). [10 marks] Roxy's WACC with leverage is: Roxy's return on equity: The value of Roxy Inc. is now: Is the investment worth pursuing (Yes/No). [SHOW YOUR WORKING] (d) After you complete your analysis in part (C), you learn that Roxy does actually pay a corporate tax of 35%. Describe the effect of corporate taxes on (i) Roxy's WACC and (ii) Roxy's expected value. [10 marks] Roxy's WACC is: Roxy's value is: [SHOW YOUR WORKING]
