Simply Bella Berhad: Modigliani - Miller Theorem Analysis
i. Calculate the pre-tax WACC of Simply Bella Berhad
The pre-tax WACC of Simply Bella Berhad is 8.8%.
ii. Synthesize the unlevered value of Simply Bella Berhad
The unlevered value of Simply Bella Berhad is RM 10 million.
iii. Compute the levered WACC of Simply Bella Berhad considering corporate taxes
The levered WACC of Simply Bella Berhad considering corporate taxes is 7.84%.
iv. Synthesize the levered value of Simply Bella Berhad
The levered value of Simply Bella Berhad is RM 137.5 million.
Explanation
1. The pre-tax WACC is calculated as the weighted average of the cost of equity and the cost of debt, where the weights are the proportions of debt and equity in the company's capital structure. In this case, the cost of equity is 10%, the cost of debt is 4%, and the debt-to-equity ratio is 2. This gives us a pre-tax WACC of:
WACC = (0.5)(10%) + (0.5)(4%) = 8.8%
2. The unlevered value of a company is the value of the company if it had no debt. It is calculated by discounting the company's free cash flows (FCF) to the present using the cost of equity. In this case, the FCF is RM 10 million and the cost of equity is 10%. This gives us an unlevered value of:
VU = FCF / r = 10 / 10 = RM 10 million
3. The levered WACC is the WACC of a company that has debt. It is calculated as the pre-tax WACC plus the tax shield benefit of debt. The tax shield benefit is the amount of tax that the company saves by using debt. In this case, the corporate tax rate is 20%, so the tax shield benefit is 0.2 * 4% = 0.8%. This gives us a levered WACC of:
WACC = 8.8% + 0.8% = 7.84%
4. The levered value of a company is the value of the company taking into account the tax shield benefit of debt. It is calculated by discounting the company's FCF to the present using the levered WACC. In this case, the levered WACC is 7.84% and the FCF is RM 10 million. This gives us a levered value of:
VL = FCF / r = 10 / 0.0784 = RM 137.5 million What is the concept of pre-tax WACC? The pre-tax WACC is the weighted average cost of capital of a company before taking into account the tax effects. It is calculated as the weighted average of the cost of equity and the cost of debt, based on the proportion of debt and equity in the company's capital structure.