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Calculation Of Weighted Average Cost Of Capital And Cash Flows

Question

I-Coupon is a publicly listed firm that offers subscribers discount coupons to a wide variety of stores and restaurants in metropolitan areas in the US. The firm recently has struck deals with key retailers for competitive one-day only discounts. I-Coupon is entering a fast growth phase, which is expected to last for 5 years. The following table contains income statement information for the most recent year 2013 (all numbers are in $1,000s).

Year

2013

 

Revenues

2,500

Operating Costs (incl. Depreciation.)

1,250

EBIT

1,250

Interest expense

560

EBT

690

Taxes

276

Net Income

414

Detailed projections (in $1,000s) for the years 2014-2018 are given below:

  • Expected growth in revenues is 100% per year.
  • Operating profit (EBIT) equals 50% of revenues in each of the years 2014-2018.
  • The increase in net working capital equals 20% of revenues in each of the years 2014-2018.
  • Gross investments in fixed assets equal $1,500 in each of the years 2014-2018.
  • The amount of depreciation is equal to $500 in each of the years 2014-2018.

At the beginning of 2014, I-Coupon has 4 million shares outstanding and has a debt ratio of 25% in market value terms. The firm has a BBB bond rating and its equity beta equals 2.86. The interest rate on T-bonds equals 3.5%, the expected yield on BBB-rated bonds is 5% and the market risk premium is 5%. Finally, you can assume that all cash flows will be realized at the end of the year and that the firm is subject to a 40% marginal corporate tax rate. With this information answer the following four questions.

(i) Determine the relevant cash flows for a valuation of the firm for the years 2014-2018 (in $1,000s). Show your calculations.

(ii) Calculate the weighted average cost of capital for I-Coupon.

(iii) Determine I-Coupon’s business risk (or asset beta). Show all your calculations.

(iv) If we assume that I-Coupon immediately lowers its target leverage (D/V) to 10% with no change in bond rating, and will maintain a constant growth rate of 3.5% after 2018, what would I-Coupon’s share price be at the beginning of 2014? Show all your calculations.

 

Summary

The question belongs to Finance and it discusses about calculation of weighted average cost of capital and cash flows.

Total Word Count 294

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