Cost of Equity:
Cost of equity is defined as the return required by the person who controls or bears the ownership risk of the company. This can be calculated using various methods, however we use CAPM method to calculate it.Â (Eugene F.Famaa, 1997)
Cost of Equity | |
Risk free rate | 2.56% |
Market risk premium | 5.90% |
Equity Beta | 1.51 |
Cost of Equity | 11.47% |
To calculate the cost of equity, we take 2.56% 10-year treasury bond rate as a risk-free rate along with this, we take 5.90% as a market risk premium hence the resulted cost of equity is 11.47%.
Weighted Average Cost of Capital:
Weighted average cost of capital (WACC) is defined as the return required by the firmâ€™s capital providers. This return is proportionate according to the value of each capital provider.Â (WSO)
Broadway intends to acquire Landmark Facility Solution either through debt or with the mixture of debt and equity. Therefore, we calculate WACC under each of the options.
Weighted Average Cost of Capital | |||
Â | Base | 100% Debt Finance | Debt and Equity Finance |
Market value of Debt | 7.9 | Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â 127.90 | Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â 67.90 |
Market value of Equity | 43.13 | 43.13 | Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â 103.13 |
Debt/Equity Ratio | 18.31% | 296.51% | 65.84% |
Equity beta | 1.25 | Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â 3.26 | 1.59 |
Cost of equity | 9.92% | 21.81% | 11.95% |
Cost of debt | 4.50% | 5.50% | 5% |
WACC | 8.83% | 8.17% | 9.19% |
Current WACC: The current WACC of the company is approximately 8.83%. For calculating this, we take themarket value of debt and equity from the financial results of 2014.
100% Debt Finance: If Broadway finance the acquisition through 100% debt, then the value of the debt will be increased by the consideration which is 120million along with this, the required return on equity and debt will also become 21.81% and 5.50% respectively due to the change in the risk of the company and in result, the WACC of the company will become 8.17%.
50%Debt and 50% Equity: If Broadway finance the acquisition partially through debt and equity, then the value of the debt and equity will be increased to 67.90 and 103.13 respectively. Along with this, the required return of equity and debt provider will also increase to 11.95% and 5% respectively and inresult, the WACC of the company will become 9.19%.
Answer 3
Mostly discounted cash flow method is used forthe valuationpurposes. By using this method, we can evaluate a project, asset or a company. In this method, we estimate all future cash flows and then discount them using WACC of the company.
We calculate the value of Landmark Facility Solution under all three cases: base, 100% debt finance and mixture of debt and equity finance.In our calculationwe take the estimated free cash flows of the company along with this, we take terminal value using the terminal growth rate of 4% and WACC of all three cases hence the resulted DCF of the company under base, 100% debt finance and mixture of debt and equity finance are 25.6million, 30million, and 23.7million respectively.
Â | FCF | ||
Year | Base | 100% Debt Finance | 50% debt and 50% equity finance |
2015 | 0.7 | 0.7 | 0.7 |
2016 | 1.0 | 1.0 | 1.0 |
2017 | 1.2 | 1.2 | 1.2 |
2018 | 1.4 | 1.4 | 1.4 |
2019 | 1.6 | 1.6 | 1.6 |
Terminal Value | 35.2 | 40.8 | 32.8 |
DCF | $25.6 | $30.0 | $23.7 |
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