Corporate Finance

1.       1

aAn  An all-equity firm is considering the following projects:

The T-bill rate is 3.5%, and the expected return on the market is 11%.

a.        Which projects have a higher expected return than the firm’s 11% cost of capital?

b.       Which projects should be accepted?

c.        Which projects would be incorrectly accepted or rejected if we used the firm’s overall cost of capital?

2.

Good Food Corporation, a public company, is currently a leading global food service retailer. It operates about 10,000 restaurants in 100 countries. Good Food serves a value-based menu focused on hamburgers and French fries. The company has $4 billion in market valued debt and $2 billion in market value equity. Its tax rate is 20%. Good Food has estimated its cost of debt as 5% and its cost of equity as 10%.

Good Food is seeking to grow by acquisition and has identified a potential acquisition candidate, Happy Meals. Happy Meals is currently a private firm with no publicly traded stock, but has the same product mix as Good Food and is a direct competitor to Good Food in many markets. Happy Meals has $1,318.8 million of debt outstanding, with its market value the same as the book value. It has 12.5 million shares outstanding. Since Happy Meals is a private firm, we have no stock market price to rely on for our valuation. Happy Meals expects its EBIT in year 1 to be equal to $150 million, and to grow at 10% a year for the next 5 years. Increases in NWC and capital spending are both expected to be 24% of EBIT. Depreciation will be 8% of EBIT. The perpetual growth rate in cash flow after 5 years is estimated to be 2%.

a)       What is Good Food’s after-tax WACC?

b)      Estimate the FCFs from Happy Meals; calculate its terminal value and present value.

c)       What is the maximum price (in $/share) that Good Food would be willing to pay for Happy Meals?