Question: In the face of disappointing earnings results and increasingly assertive institutional stockholders, Eastman Kodak was considering the sale of its health division, which earned $560 million in earnings before interest and taxes in 1993, on revenues of $5.285 billion. The expected growth in earnings was expected to moderate to 6% between 1994 and 1998, and to 4% after that. Capital expenditures in the health division amounted to $420 million in 1993, while depreciation was $350 million. Both are expected to grow 4% a year in the long term. Working capital requirements are negligible. The average beta of firms competing with Eastman Kodak's health division is 1.15. While Eastman Kodak has a debt ratio (D/(D+E)) of 50%, the health division can sustain a debt ratio (D/(D+E)) of only 20%, which is similar to the average debt ratio of firms competing in the health sector. At this level of debt, the health division can expect to pay 7.5% on its debt, before taxes. (The tax rate is 40%, and the treasury bond rate is 7%.)
a. Estimate the cost of capital for the division.
b. Estimate the value of the division. 11. You have been asked to value Alcoa and have come up with the following inputs.
• The stock has a beta of 0.90, estimated over the last 5 years. During this period, the firm had an average debt/equity ratio of 20% and an average cash balance of 15%.
• The firm's current market value of equity is 1.6 billion and its current market value of debt is $800 million. The current cash balance is $ 500 million.
• The firm earned earnings before interest and taxes of $ 450 million, which includes the interest income on the current cash balance of $ 50 million. The firm's tax rate is 40%.
• The firm is in stable growth, and its earnings from operations are expected to grow 5% a year. The net capital expenditures next year are expected to be $ 90 million. Estimate the value of the non-cash assets of the firm, its total value, and the value of its equity.