Final answer:
Using the WACC and perpetuity formula with the given cash flow, the firm's enterprise value is calculated to be $62.5 billion. Thus, the correct answer is option B.
Step-by-step explanation:
The question asks us to calculate the enterprise value of a firm given its free cash flow, capital structure, cost of debt, and cost of equity. To calculate the enterprise value, we must first calculate the firm's Weighted Average Cost of Capital (WACC), which can be found using the formula:
WACC = (E/V) * Re + (D/V) * Rd
Where:
- E = Market value of the equity
- V = Total market value of the firm's financing (Equity + Debt)
- Re = Cost of equity
- D = Market value of the debt
- Rd = Cost of debt
Since the firm is financed by 50% equity and 50% debt, E/V and D/V both equal to 0.5. With no taxes, the formula simplifies to:
WACC = 0.5 * 10% + 0.5 * 6% = 8%
Using the perpetuity formula to calculate enterprise value, where cash flow is divided by the WACC:
Enterprise Value = Free Cash Flow to the Firm / WACC
Given a free cash flow of $5 billion and a WACC of 8%, the enterprise value is:
Enterprise Value = $5 billion / 0.08 = $62.5 billion
Therefore, option B ($62.5 billion) is the correct answer for the firm's enterprise value.