Solved: Find Fiat s weighted average cost of capital under

each of

Find Fiat's weighted average cost of capital under each of the following scenarios.

a. Fiat has a market value debt-to-value ratio of 25 percent. The euro risk-free rate is 5 percent.
The risk premium in the Italian stock market is 5 percent. Fiat has a beta is 1.5 when measured
against the Italian market. Fiat's pretax borrowing cost in Milan on new long-term euro-
denominated debt is 6 percent. Interest payments are tax deductible in Italy at the marginal
corporate income tax rate of 40 percent.

b. Suppose Fiat appeals to international investors by listing on the London stock exchange. Fiat
can borrow in the London market at a pretax cost of 5.5 percent. The euro risk-free rate is 5
percent. International investors are willing to tolerate a 40 percent debt-to-value mix at this cost
of debt. With a 40 percent debt-to-equity ratio, the beta of Fiat is 1.5 against the MSCI world
index. The risk premium on the world market portfolio is 4 percent.

c. Suppose Fiat will generate after-tax operating cash flow of 20 million euros in the coming
year, and that this is expected to grow at a g = 1 percent rate in perpetuity. Use the equation V0
= CF1/(i - g) to value Fiat, given CF1 is the coming year's cash flow, a weighted average cost of
capital of iWACC, and a growth rate of g. Find Fiat's value using the weighted average costs of
capital from a) and b). By how much can Fiat increase its value by appealing to international
investors?

ANSWER
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