Question

ABC Incorporated has operating income before interest and taxes in 2020 of $199.2 million. The firm is expected to generate this level of operating income indefinitely. The firm had depreciation expense of 10 million that same year. Capital spending totaled 20 million during 2020. At the end of 2019 and 2020, working capital totaled 70 and 80 million, respectively. The firm's combined marginal state, local, and federal tax rate was 30% and its debt outstanding had a market value of 1.2 billion. The 10 year Treasury bond rate is 2% and the borrowing rate for companies exhibiting levels of creditworthiness similar to ABC is 5%. The historical risk premium for stocks over the risk free rate of return is 5.5%. ABC's beta was estimated to be 1.0. The firm has 2,500,000 common shares outstanding at the end of 2020. ABC's target debt to total capital ratio is 30%.
1. The free cash flow to the firm in 2020 (in million).
2. The WACC is (in percentage).
3. The firm value is million.

Answer 1

Answer and Explanation:

The computation is shown below:

1. Free cash flow

= EBIT × (1 - tax rate) + depreciation expense - capital expenditure - change in net working capital

= $199.2 × (1 - 0.30) + $10 - $20 - ($80 - $70)

= $119.44

2. The WACC is  

But before that following calculations need to be done

Cost of equity = (2 + 1 × 5.5)

= 7.50%

The cost of debt is 5%

The debt to total capital ratio is 30%

The equity to total capital ratio is (100 - 0.30) = 0.70

Tax rate is 30%

Now

WACC is  

= (7.5 × 0.7 + 5 × 0.3 × (1 - 0.3))

= 6.30%

3. The firm value is

= $119.44 ÷ 0.063

= $1,895.87 million