Question

- Problem 6-6 Free Cash Flow Model (LO3, CFA7)

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 1.7, a debt-to-equity ratio of .7, and a tax rate of 21 percent. Assume a risk-free rate of 3 percent and a market risk premium of 8 percent. Lauryn’s Doll Co. had EBIT last year of $59 million, which is net of a depreciation expense of $5.9 million. In addition, Lauryn's made $7.3 million in capital expenditures and increased net working capital by $2.4 million. Assume the FCF is expected to grow at a rate of 4 percent into perpetuity. What is the value of the firm? (Do not round intermediate calculations. Enter your answer in millions rounded to 2 decimal places.)

Firm Value = ________ million

Answer 1

1. Computation of Asset beta

Asset Beta Equity beta / (1 + DE ratio * (1 - tax))

Asset Beta =1.70/ (1 + 0.70 * (1 - 0.21))

Asset Beta =1.09

2. Cost of capital = Risk free + beta * market risk premium = 3.% + 1.09 * 8% = 11.76%

3. Free cash flow = EBIT * (1 - Tax) + depreciation - Changes in net working capital - capital expenditures

Free cash flow = 59 M * (1 - 0.21) + $5.90 M - 2.40 M - 7.30 M

Free cash flow = $42.81 M

4. Firm value = FCF * (1 + growth rate) / (required rate - growth rate)

Firm value = 42.81 M * (1 + 4%) / (11.76% - 4%)

Firm value = $573.95 Million