Question

You are going to value Lauryn’s Doll Co. using the FCF model. After consulting various sources, you find that Lauryn's has a reported equity beta of 1.5, a debt-to-equity ratio of .5, and a tax rate of 21 percent. Assume a risk-free rate of 5 percent and a market risk premium of 8 percent. Lauryn’s Doll Co. had EBIT last year of $47 million, which is net of a depreciation expense of $4.7 million. In addition, Lauryn's made $7.25 million in capital expenditures and increased net working capital by $2.8 million. Assume the FCF is expected to grow at a rate of 4 percent into perpetuity. What is the value of the firm?

What Firm Value？

Answer 1

- Unlevered beta = Equity beta/[1+ (1- Tax rate)*Debt/Equity]

Unlevered beta = 1.5/[1+(1-0.21)*0.5/1]

Unlevered beta = 1.0753

As per CAPM,

where, rf = Risk free return = 5%

Rmp = Market Risk Premium = 8%

Unlevered beta = 1.0753

Required rate of Return = 5% + 1.0753(8%)

Required Return or Unlevered Cost of equity = 13.6024%

- Unlevered Cost of equity does not have debt levereage and thus is same as WACC.

- Calculating Free cash flow(FCF0) of Last year:-

FCF0 = EBIT(1-Tax rate) + Depreciation - Change in Net Working Capital - Net Capital Expenditure

FCF0 = $47 million*(1-0.21) + $4.7 million - $2.8 million - $7.25 million

FCF0 = $31.78 million

Calculating Enterprise Value:-

EV = FCF0(1+g)/WACC-g)

where, WACC = 13.6024%

g = Growth rate of FCF = 4%

EV = $31.78 million(1+0.04)/(0.136024 - 0.04)

EV = $344.20 million

So, the value of the firm is $344.20 million

If you need any clarification, you can ask in comments.    

If you like my answer, then please up-vote as it will be motivating