In year 1, AMC will earn $2,400 before interest and taxes. The market expects these earnings to grow at a rate of 2.9
Posted: Sun Jul 03, 2022 12:54 pm
In year 1, AMC will earn $2,400 before interest andtaxes. The market expects these earnings to grow at a rate of 2.9%per year. The firm will make no net investments (i.e.,capital expenditures will equal depreciation) or changes tonet working capital. Assume that the corporate tax rate equals25%. Right now, the firm has $6,000 in risk-freedebt. It plans to keep a constant ratio of debt to equityevery year, so that on average the debt will also grow by2.9% per year. Suppose the risk-free rate equals 4.8333%,and the expected return on the market equals 10.633%. The assetbeta for this industry is 1.12.
a. If AMC were an all-equity (unlevered) firm, whatwould its market value be?
b. Assuming the debt is fairly priced, what is the amountof interest AMC will pay next year? If AMC's debt isexpected to grow by
2.9%
per year, at what rate are its interest payments expectedto grow?
c. Even though AMC's debt is riskless (the firm willnot default), the future growth of AMC's debtis uncertain, so the exact amount of the future interestpayments is risky. Assuming the future interest payments have thesame beta as AMC's assets, what is the present valueof AMC's interest tax shield?
d. Using the APV method, what is AMC's totalmarket value,
VL?
What is the market value of AMC's equity?
e. What is AMC's WACC?
(Hint:
Work backward from the FCF and
VL.)
f. Using the WACC, what is the expected return forAMC equity?
g. Show that the following holds for AMC:
βA=ED+EβE+DD+EβD.
h. Assuming that the proceeds from any increases in debt arepaid out to equity holders, what cash flows do the equityholders expect to receive in one year? At what rate are thosecash flows expected to grow?
a. If AMC were an all-equity (unlevered) firm, whatwould its market value be?
b. Assuming the debt is fairly priced, what is the amountof interest AMC will pay next year? If AMC's debt isexpected to grow by
2.9%
per year, at what rate are its interest payments expectedto grow?
c. Even though AMC's debt is riskless (the firm willnot default), the future growth of AMC's debtis uncertain, so the exact amount of the future interestpayments is risky. Assuming the future interest payments have thesame beta as AMC's assets, what is the present valueof AMC's interest tax shield?
d. Using the APV method, what is AMC's totalmarket value,
VL?
What is the market value of AMC's equity?
e. What is AMC's WACC?
(Hint:
Work backward from the FCF and
VL.)
f. Using the WACC, what is the expected return forAMC equity?
g. Show that the following holds for AMC:
βA=ED+EβE+DD+EβD.
h. Assuming that the proceeds from any increases in debt arepaid out to equity holders, what cash flows do the equityholders expect to receive in one year? At what rate are thosecash flows expected to grow?