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Hello john! In the question it was asked to calculate the WACC before and after redeeming 70% of the loan the company had two operations the hotel services and the property business. In the model answer the cost of equity was only calculated for the hotel services and WACC for hotel services and completely ignored the property business.
In the calculation before implementation of that strategy the WACC was calculated using the current beta of the company which contained both property business and the hotel services but in the second calculation of WACC the asset beta of property business was completely ignored, and cost of equity was calculated using the geared beta of hotel services. Why is that the case that we completely ignore the asset beta of property business when we used it in our previous calculation the numbers won’t be comparable.
The asset beta of the property business was given which could have easily been regeared and then using an average beta the cost of equity could have been calculated like this:Degear to calculate the asset beta of hotel services 0.755
Regear to calculate equity beta after implementation 0.936
asset beta of property business 0.4
gear the asset beta of property business 0.496
average beta of the business 0.76I have no clue why it was ignored and can you please clarify this. also is submitted a question a few days ago i think you missed it. Thank u
Also, Sir john in the same question it was stated that
“Coeden Co’s latest free cash flow to equity of $2,600,000 was estimated after taking into
account taxation, interest and reinvestment in assets to continue with the current level of
business. It can be assumed that the annual reinvestment in assets required to continue with
the current level of business is equivalent to the annual amount of depreciation. Over the
past few years, Coeden Co has consistently used 40% of its free cash flow to equity on new
investments while distributing the remaining 60%. The market value of equity calculated on
the basis of the free cash flow to equity model provides a reasonable estimate of the current
market value of Coeden Co.”
Why is the case that in the calculation we do not use $2,600,000*0.6 as the dividends because it states that only 60% of the free cash flows are used as dividends but in the model answer the whole $2,600,000 was used as the dividend.For your first question:
The current equity beta is that for the whole company (which is both hotels and property) and so it this that is relevant when calculating the current WACC.
When they sell the property business they are left with just hotels and so then we need to calculate the beta of just the hotel business in order to be able to calculate the new WACC.
For your second question, the 2,600,000 is the current amount payable as dividend. Thanks to the retention is will be growing in the future and so the growth formula has been used to calculate the PV of the dividend stream.
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