SuperOnline is a company composed of two divisions: online commerce and fintech. It is planning to spin off its fintech division. Currently, SuperOnline has 10 million shares of stocks trading at $170. Its debt / value ratio is 10%. It will keep its debt amount constant forever (even after spin-off). Online commerce division’s EBIT is expected to be 100 million at the end of this year and grow 2% every year. Fintech division’s EBIT is expected to be 50 million at the end of this year and is expected to grow 7% every year. Fintech division’s current debt is 150 million and it will keep the debt amount constant (even after spin-off). EasyFintech is SuperOnline’s fintech business rival and it is only in fintech business. EasyFintech’s debt/equity ratio is 25%, its cost of equity is 15%. Assume all debts are riskless. Risk-free rate is 10%. Market Risk premium is 8%. Tax rate is 35%.

Required:
a. What is cost of capital for SuperOnline’s fintech division?
b. What is the fair value of SuperOnline's fintech division's equity?
c. Compute the value and debt of online commerce division of SuperOnline.
d. What is cost of capital of SuperOnline’s online commerce division?

a. Similar companies will mean the same capital cost outlay. Hence, levered beta is calculated as 0.63 while unlevered beta is put at 0.54. Fintech capital cost is calculated as 13.8%.

b. The equity value of Fintech division is then calculated as 327.90 million

c. To calculate the value and debt of online commerce division we put it at 1,410.99 million

d. We calculate the cost of capital of SuperOnline’s online commerce division as 6.61%

Explanation:

a. Similar companies will mean the same capital cost outlay.

First of all we calculate the cost of equity= ( beta*market risk premium )+ risk free rate

Levered beta = (cost of equity - riskfree rate)/market risk premium= ( fifteen percent minus ten percent) divided by eight percent= 0.63

Unlevered beta = levered beta/(1+(1-Tax rate)*D/E) = 0.63/(1+(1-35%)*25%) = 0.54

To calculate Fintechs unleavered beta we use super online D/E ratio

Ten percent divided by Ninety percent= 11.11%

unlevered beta*(1 + (1-Tax rate)*D/E) = 0.54*(1+(1-35%)*11.11%) = 0.58

Cost of equity for Fintech division (using CAPM) = Ten percent + (0.58*Eight percent) = 14.61%

Cost of debt = Ten percent (given as the riskfree rate)

So, using the capital structure ratio of SuperOnline,

cost of capital for the Fintech division = (debt ratio*cost of debt*(1-Tax rate)) + (equity ratio*cost of equity)

= (Ten percent*Ten percent*(1-Thirty five percent)) + (Ninety percent*14.61 percent) = 13.80 percent

b. To calculate the value of equity of Fintech dvisions

Value of Fintech operations (Vo) = EBIT*(1-Tax rate)/(WACC - growth rate) = 50*(1-Thirty five percent)/(13.80%-Seven percent) = 477.90 million

Therefore, equity value of Fintech division = Vo - debt value = 477.90 - 150 = 327.90 million

c). Value of operations for SuperOnline = equity value/equity ratio = (price per share*number of shares)/(E/V ratio)

= (10*170)/90% = 1,888.89 million

Value of commerce division = value of SuperOnline - value of Fintech division

= 1,888.89 - 477.90 = 1,410.99 million

Therefore, debt of SuperOnline = Value of operations - equity value = 1,888.89 - 1,700 = 188.89 million

Thus, debt value of commerce division = debt of SuperOnline - debt of Fintech division

= 188.89 - 150 = 38.89 million

d. Value of operations of commerce division = EBIT*(1-35%)/(WACC - 2%)

Therefore, cost of capital of SuperOnline’s online commerce division is

WACC = (EBIT*(1-Thirty five percent)/1,410.99) +Two percent = (100*(1-Thirty five percent)/1,410.99) + Two percent = 6.61%