1. Facebook, Inc., is an unlevered firm. From its existing web based operations, it is expected to generate annual earnings before taxes of $20 million next year. It is expected to grow at a rate of 7% for the next three years after when it will drop to 2% for next two years. The growth rate, however, will remain at 5% thereafter. The current beta of the company's stock is 1.2 and market risk premium is 10% with risk free rate at 5%. The company has 2.5 million shares of common stock outstanding and is subject to a corporate tax rate of 35 percent. The firm is planning a recapitalization under which it will issue bond to make the debt equity ratio at 0.7 to be optimum. 7% coupon bonds will be issued with infinite maturity and with YTM of 9 percent and use the proceeds to buy back shares.
A. Calculate the value of the firm and share price before recapitalization.
B. Applying APV method, calculate the value of the firm and share price after the recapitalization.
C. Using Flow to Equity Method, calculate the value of the firm and share price after recapitalization.
D. Instead of repurchasing of shares, Facebook is considering a project that will require purchasing an equipment by the 90% of the debt. Remaining 10% will be used for working capital requirement. The project will last for six years generating cash flows of $5.8 every year. The equipment will have $580,000 salvage value. This project is about 20% more risker than the existing business operations. Would you recommend to go ahead with this decision? Why or why not? To receive maximum credit, provide your justification clearly why and how you made your decision.
2. Twitter Inc. has its ongoing business where it sells 50,000 units of mobile app every year. It costs $20 per unit and the contribution margin is $5 per unit. Annual fixed cost is $100,000 with a depreciation expense of $40,000 per year. It is an ongoing business every year forever. The firm can borrow at 7 percent. Twitter currently has no debt, and its cost of equity is 13 percent and the tax rate is 35 percent. The company borrows $136,000 and uses the proceeds to repurchase shares. What is the cost of equity and WACC after recapitalization?