Question 3

Firm W reports an annual expected EBITDA of 10M€ with annual capital expenditures (CAPEX) of 5M€ and an equivalent amount of 5M€ in annual depreciation. The corporate tax rate is 40%. Cash flows are perpetuities.

Firm W capital structure has debt and equity. The debt is composed of 5 000 bonds, each paying an annual coupon (interest) of 60€ and offering the reimbursement of a principal (nominal value) of 1 000€ at maturity in 20 years. The risk of default is negligible making these bonds risk-free. Equity is composed of 10 000 shares trading at a price of 1 000€ per share. The company intends to keep its capital structure constant in the future. Thus, the debt will be renewed at the exact same conditions (coupon rate, interest rate, principal repayment at maturity and maturity) every 20 years when the bonds come to maturity and this to infinity.

The risk-free rate is 6% and the expected return of the market is 14%.

a) Calculate the market price of a bond.

b) Calculate the total market value of equity, bonds, and the firm.

c) Calculate the cash flows to equityholders, the cost of equity, the beta of equity and the cost of capital (WACC) of W. 

d) What would be the equity beta of W if it was unlevered (no debt)? What would be its cost of equity and WACC?  

e) In order to get the firm unlevered, the firm’s CFO announces that the firm will issue new equity in order to fully reimburse the debt. What will be the impact of this financial operation on the actual stock price of the firm.