Chapter 19 Financing and Valuation 519
bre44380_ch19_491-524.indd 519 09/30/15 12:07 PM
Historical Forecast
Year: – 2 – 1 0 1 2 3 4 5- Sales 35,348 39,357 40,123 36,351 30,155 28,345 29,982 30,450
- Cost of goods sold 17,834 18,564 22,879 21,678 17,560 16,459 15,631 14,987
- Other costs 6,968 7,645 8,025 6,797 5,078 4,678 4,987 5,134
- EBITDA (1 – 2 – 3) 10,546 13,148 9,219 7,876 7,517 7,208 9,364 10,329
- Depreciation 5,671 5,745 5,678 5,890 5,670 5,908 6,107 5,908
- EBIT (Pretax profit) (4 – 5) 4,875 7,403 3,541 1,986 1,847 1,300 3,257 4,421
- Tax at 35% 1,706 2,591 1,239 695 646 455 1,140 1,547
- Profit after tax (6 – 7) 3,169 4,812 2,302 1,291 1,201 845 2,117 2,874
- Change in working capital 325 566 784 – 54 – 342 – 245 127 235
- Investment (change in gross fixed assets) 5,235 6,467 6,547 7,345 5,398 5,470 6,420 6,598
❱ TABLE 19.5 Cash flow projections for Chiara Corp. ($ thousands).
On the other hand, she points out that the company can raise new debt on a 7% yield,
which would make the cost of new debt 8½%. She therefore recommends that Bunsen should
go ahead with the project and finance it with an issue of long-term debt.
Is Ms. Ethylene right? How would you evaluate the project?- WACC Nevada Hydro is 40% debt-financed and has a weighted-average cost of capital
of 9.7%:
WACC = (1 − Tc)rD __D
V
- rE __E
V
= (1 − .35)(.085)(.40) + .125(.60) = .097
Goldensacks Company is advising Nevada Hydro to issue $75 million of preferred stock at
a dividend yield of 9%. The proceeds would be used to repurchase and retire common stock.
The preferred issue would account for 10% of the pre-issue market value of the firm.
Goldensacks argues that these transactions would reduce Nevada Hydro’s WACC to 9.4%:WACC = (1 − .35)(.085)(.40) + .09(.10) + .125(.50)
= .094, or 9.4%
Do you agree with this calculation? Explain.- Company valuation Chiara Company’s management has made the projections shown in
Table 19.5. Use this table as a starting point to value the company as a whole. The WACC for
Chiara is 12% and the long-run growth rate after year 5 is 4%. The company has $5 million
debt and 865,000 shares outstanding. What is the value per share?
CHALLENGE
- Miles-Ezzell formula In footnote 15 we referred to the Miles–Ezzell discount rate formula,
which assumes that debt is not rebalanced continuously, but at one-year intervals. Derive this
formula. Then use it to unlever Sangria’s WACC and calculate Sangria’s opportunity cost of
capital. Your answer will be slightly different from the opportunity cost that we calculated in
Section 19-3. Can you explain why? - Rebalancing The WACC formula assumes that debt is rebalanced to maintain a constant
debt ratio D / V. Rebalancing ties the level of future interest tax shields to the future value
of the company. This makes the tax shields risky. Does that mean that fixed debt levels (no
rebalancing) are better for stockholders?