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**Corporate Valuation and Financing Exercises Session 3 «Valuing levered and companies, the wacc»**

Laurent Frisque - Steve Plasman –

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Q1 Modigliani Miller I Q1: To value: Freshwater Corp. No taxes and perfectly efficient markets. Currently the company is not levered all. EBIT per year: $ and should remain the same perpetually. The cost of equity of the company is worth 12% =Re. In this case what is the value of the company?

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Q1 Modigliani Miller I Q1: In this case what is the value of the company? The cost of equity of the company is worth 12% =Re=Ra (no leverage). Vunlevered = EBT / Ra (no Interests) = / 12% =

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Q1 Modigliani Miller I Q1: To value: Freshwater Corp. Issue a perpetual debt for which you pay $, to buy back shares. Interest each year (the borrowing rate of the company is 3%) What would then be the market value of the company? Interests = Rd = 3% D = Vu = E = (E + D = Vu)

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Q1 Modigliani Miller I Q1: And of ra , the wacc, and re? Ra = 12% Unchanged by definition Re*E = Ra*Vu - Rd*D Re = (Ra*Vu - Rd*D)/ E = 14,84% Or Re = (EBT – I) / E Wacc = 12% (because NO taxes)

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**Q2 Valuing levered Companies in a world with taxes**

Q2: Bobland, not a perfect world: Corporate tax rates: 25% (Tc) Same capital structure and revenues as in Tongoland. What is the value of the levered company? (Vl) EBIT = (Unlevered) EBIT (1-Tc) = Vunlevered = EBIT (1-Tc) / Ra = / 12% = Interests = Rd = 3% D = I/Rd = Tax Shield = Tc*D = V levered = Vu + Tax Shield =

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**Q2 Valuing levered Companies in a world with taxes**

Q2: And of ra, the wacc, and re? Ra = 12% Unchanged by definition Wacc = EBIT * (1-Tc) / VL = 11,11% Atlernative: L = D/VL Wacc = Ra * (1 – Tc*L) E = VL – D = Net Earnings = (EBIT-I) * (1-Tc) Re = Net Earnings / E = 14,84% Re = Ra + (Ra – Rd) * (1-Tc)* D/E

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**Q3 Marginal versus Average Tax RateValuing**

Q3: The subsidiary has an EBIT of $. The tax structure in Sloland: the first $ are tax exempt the following $ taxed at 20% any amount above that is taxed at 30%. Issue a perpetual debt 75000$ to benefit from the tax shield. Skeptical with an average tax rate. Cost of debt (= risk free rate: 4%), he values the tax shield at $ Hardly interesting in view of the costs associated with a debt issue. A. Is he right? B. What would have been the tax shield if the debt had been reimbursed after two years?

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**Q3 Marginal versus Average Tax RateValuing**

Q3: A. Is he right? Issue a perpetual debt worth 75000$ to benefit from the tax shield Average tax rate = 14% D = PV Tax Shield = D * Average Tax Rate = EBIT = Interest payment = * 4% = 3.000 Tax saving = 900 (perpetual) PV Tax saving =

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**Q3 Marginal versus Average Tax RateValuing**

Q3: B. What would have been the tax shield if the debt had been reimbursed after two years?

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**Q4 Leveraging and deleveraging Betas, Company valuation using the WACC**

Q 4: In 2010, Acquisition of Wellstream. Competitors Technip and Prysmian. Risk Higher: GE’s WACC is not appropriate to value this acquisition. You get following data: Target D/E for Wellstream acquisition: 0.4 Wellstream’s expected real asset cash-flows next year: 50 million $ Growth rate of Wellstream’s cash-flows: 1.5% per year Marginal corporate tax rate: 20% Discount rate on debt: 2% (riskless rate) Expected return of the market portfolio: 7% Comparison Be D/E P/B D/ Market Cap Tax rate 1-T GE 1,16 1,67 2,75 61% 15% 85% WSM 1,30 1,0 7 14% 25% 75% Technip 1,35 1,85 0% 33% 67% Prysmian 1,32 0,45 3 30% 70%

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**Q4 Leveraging and deleveraging Betas, Company valuation using the WACC**

a) Estimate Wellstream’ beta of operating assets from the peers. You overheard Technip has also another division, so you may have to eliminate it.

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**Q4 Leveraging and deleveraging Betas, Company valuation using the WACC**

b) Compute the WACC for the Wellstream’s acquisition. WACC = Re *E/VL + Rd *(1-Tc)*D/VL c) Determine the value of this acquisition with the WACC computed in b), knowing that Wellstreams’s debt is valued at 50 million $. MARKET VALUE of E !!

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**Q4 Leveraging and deleveraging Betas, Company valuation using the WACC**

d) Determine the value of Wellstream with GE’s WACC. e) Apply the adjusted present value method to value Welstream’s acquisition

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Q5 APV and wacc Analyse the interest of a new project. The following data are available. Initial investment of 1 million € in year 0 Additional EBIT of € during 5 years (years 1 to 5). After year 5 there will be no more sales WCR constant for the whole project. No depreciation Target leverage ratio of 50% Ra 10% rd= rf= 5% Marginal corporate tax rate Tc = 30%.

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Q5 APV and wacc Should the company launch the project? Base Case Vu - I What is the value of the wacc?

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Q5 APV and wacc B. What is the value of the wacc? Target leverage ratio L = D/ V constant V = PV of remaining after tax cash flow wacc Miles-Ezzel = Ra - L*Tc*Rd*(1+Ra)/(1+Rd) C. How would the value of the project change if the company used a continuous rebalancing approach? Debt rebalanced continously Dt = L *VLt wacc Harris Pringle = Ra - Rd*Tc*L ! Uncertainty about next Tax shield – ! Riskier

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