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 1.4, a debt-to-equity ratio of 0.4, and a tax rate of 30 percent. Assume a risk-free rate of 3 percent and a market risk premium of 7 percent. Lauryn’s Doll Co. had EBIT last year of $45 million, which is net of a depreciation expense of $4.5 million. In addition, Lauryn's made $4.25 million in capital expenditures and increased net working capital by $4.9 million. Assume the FCF is expected to grow at a rate of 2.8 percent into perpetuity. What is the value of the firm (in millions)?

Answer 1

Free Cashflow from Equity :

Relevant Profit = PAT

For Free cashflow, we reduce equity component of net investment. Discount the free cashflows using Ke. Ke can be computed using CAPM approach

Ke = Rf + β(Rf -Rm)

       = 3%+ 1.4*7% = 12.8%

Computation of PAT :

EBIT                         = $ 45 millions

Less : Tax @ 30% = (13.5)

PAT                         = $ 31.5 millions

Computation of Net Investment (NI):

Gross Investment = CAPEX + changes in working capital

                                 = 4.25+4.9 = $ 9.15 millions

Net Investment   = Gross Investment – Depreciation

                                = 9.15-4.5 = $ 4.65 millions

Equity component of Net Investment = 4.65*.6 = $ 2.79 millions

Free Cashflow of Equity = 31.5 – 2.79 = $ 28.71 millions

Value of Firm = (FCFE*g)/ (Ke – g)

                         = (28.71*102.8%)/ 12.8-2.8

                         = $ 295.1388 millions