In this assignment, you are supposed to find the optimal value of Axfood based on the
company's capital structure. This is because the company's value depends on its future cash
flows and its discount rate. And the discount rate will vary with different capital structures.
The discount rate in the main valuation model - the Discounted cash flow model - is the
WACC. With the future cash flow unchanged, the lower the WACC, the higher the value of
the company.
The assignment should be completed in 10 steps:
1. Assume that the sum of Equity and Debt is fixed. Today's company value (FV) is fixed, i.e.,
if Debt is 0 percent, Equity is 100 percent and is equal to the company value (FV). When Debt
increases to 10 percent of FV (D/E ratio is 11.11 percent, 10/90), then Equity is 90 percent of
today's company value, etc. Estimate the value of debt and equity with the different D/E
ratios.
2. Use the levered beta that you calculated in assignment 1 (Beta Computation), to estimate
a beta for each D/E level (see the formula in the formula sheet). You first estimate the
unlevered beta and then estimate a unique levered beta for each D/E level.
3. Estimate the Risk-free rate of return and the Market Risk Premium (MRP).
4. Calculate the required rate of return ($R_e$) for each D/E level (with the unique beta for each
level).
5. Estimate the Interest coverage for each level (see the formula in the formula sheet).
6. Estimate the debt spread for each D/E level. Use spread estimation in the Table below.
7. Estimate the cost of debt (with tax reductions) for each D/E level.
8. Use the estimations in 4 and 7 to estimate the unique WACC for each D/E level.
9. Choose the D/E level with the lowest WACC.
10. Estimate the increased value of Axfood with the lowest WACC (the one you found) and
the existing WACC.
