CORPORATE FINANCE CASE STUDY
Question 1 - Find SUPERMAR’S current firm and equity values under the following capital structure scenarios: In order to calculate the cash flows the first step is to calculate the necessary inputs for the WACC. The case indicates that the current capital structure is 14% debt. We have all of the other inputs needed to calculate the cost of equity, cost of debt and WACC. The inputs are the following:
Before, calculating the actual firm value, it is important to mention some calculations made for the discounted cash flows. For the net change in working capital we included all of the current assets and liabilities. Cash is included because we saw a direct relationship between the increases in sales each year with the increase in cash, assuming that cash has been used for operational purposes. This increase over years is exactly 3.2%. On the other hand, we identified an odd behavior in the increase of CAPEX. According to accounting principles and using the correct formula of Fixed Assets to calculate the purchases, we identified a CAPEX of €3,125 per year. The formula used to calculate these values is the following: Ending PPE- Beginning PPE+ Depreciation = CAPEX
However, we took into consideration no net increase (difference between the gross depreciation, which is “0”). This is mainly because as stated in the case, SUPERMAR is not able to invest more cash as the market is saturated. For the calculation of the “g” rate we used the formula of Reinvestment rate x ROI. This yields a rate of -0.18%. Considering that the average growth rate of the Spanish economy is around 2.2% over the past 10 years, we believe that SUPERMAR is performing under a very competitive environment, this is why we assume the growth rate at -0.18%.
The cash flows calculated for the three scenarios are the following, 2007 is our year “0”:
Using these cash flows, we will attempt to find the firms value and equity value using different capital structures.
a. If capital remains at current levels
Given the inputs we arrived to a WACC of 11.38% to use for the discounted cash flows. We used the current capital structure which is 14% debt, 86% equity.
Our results considering a WACC of 11.38% and using the cash flow table above are the following:
We discount the cash flows with the same WACC throughout the following years. The level of debt we should use to find the equity value is 2,404 euros corresponding to the debt levels one year before projections (2007). The result of our valuation is the following:
b. If capital structure converges immediately to target
For this case, we had to do an extra calculation. Unlevering the beta with the current capital structure and lever it to the target which is 30% debt and 70% equity. The results are as follow:
With the new capital structure mentioned, the WACC used will be 11.84%. Our results considering this WACC and using the initial cash flow table above are the following:
We discount the cash flows with the same WACC throughout the following years (11.84%). The level of debt we should use to find the equity value is €2,404 corresponding to the debt levels one year before projections (2007). The result of our valuation is the following:
c. If capital structure converges progressively to target
Given the inputs, our capital structure will vary the following way:
As the capital structure changes towards the target (30% debt) during the following years until 2013, the WACC´s will have different values as shown above. Incorporating the new capital structures and the WACC’s for each year of projections, our results are the following:
We discount the cash flows with its corresponding WACC rate for each year. The level of debt as mentioned for the other scenarios is the same (€2,204 form year 2007). Our results are the following:
By using a constant WACC assuming that the...
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