The industry of mobile phones is experiencing a period of growing competition that erodes the profit margin and that is killing many competitors. In the last five years the field has become an oligopolistic market with room for a very limited numbers of players of big dimensions.
In such an environment the companies pay attention to the risk linked to their financial structure choices and on the impact they may show on the market value of their shares.
Mr. Krunhan, CFO of Soundsignal Company Ltd. Is considering the situation of his firm, listed on a foreign Stock Exchangebecause he is interested in evaluating the firm and in carrying out a comparison to a possible peer. Currently Soundsignal Company has 100.000 shares listed on the market with a book value per share equal to 100 dollars; it issued also 100.000 bonds with a book value of 100 dollars each one.
The current price of a share is 500 dollars and the market value of every bond is 110 dollars.
a) Estimate the enterprise value of Soundsignal Company and calculate its leverage ratio (D/E).
b) Soundsignal Company is expected to generate free cash flows to firm constant and equal to 400,000 dollars per year without changes in Net Working capital nor in the financial structure. Under these assumptions and keeping in in mind also that the company does not have to face new investments, help Mr. Krunhanto estimate his weighted average cost of capital.
c) On the basis of the cost of debt resulting from the probability of default recognized to the company, that implies to add a premium of 2% to an initial reference interest rate equal to 2%, estimate the coherent return expected by the shareholders. You know that the taxation corporate rate is 30%.
Mr. Kruhnan is analyzing the industry. The well-known firm Mobile Devices Ltd. captures his attention. Mobile Devices is actually a competitor for Soundsignal.
Mobile Devices in in a stationary condition too and is able to generate free cash flow equal to 4.000.000 dollars every year. These free cash flows show the same systematic risk that characterizes the money expected by Soundsignal Company.
Mobile Devices is an all-equity financed firm. Its number of shares is equal to 120.000.
d) Help Mr. Krunhan to estimate the cost of equity for Mobile Devices Ltd.
e) Help him also in the estimation of the enterprise value and of the equity value for Mobile Devices.
f) Finally let's imagine that Mobile Devices decides to issue 150.000 bonds at par for a total amount of 15 million,with the aim of buying back shares. In this case what would Mr. Krunhan conclude about the new enterprise value and the new equity value? How about the Debt/Equity Ratio?