Question

In: Finance

LIS Corporation, an environmental service provider, had revenues of $209 million in 2002 and reported losses...

LIS Corporation, an environmental service provider, had revenues of $209 million in 2002 and reported losses of $3.1 million. It had earnings before interest and taxes of $12.5 million in 2002, and had debt outstanding of $109 million (in market value terms). There are 15.9 million shares outstanding, trading at $11 per share. The pre-tax interest rate on debt owed by the firm is 8.5%, and the stock has a beta of 1.15. The firm's EBIT is expected to increase 10% a year from 2003 to 2006, after which the growth rate is expected to drop to 4% in the long term. Capital expenditures will be offset by depreciation, and working capital needs are negligible. (The corporate tax rate is 40%, and the treasury bond rate is 7%.)

1. Estimate the cost of capital for LIS.

2. Estimate the value of the firm.

3. Estimate the value of equity (both total and on a per share basis).

Expert Solution

Total Outstanding shares = 15.9 million

Share price = $11

Market capitalization = $174.9

Total debt outstanding = $109 million

ENTERPRISE VALUE = MARKET CAP + DEBT - CASH&CASH EQUIVALENT (not given,assume = 0)

= 174.90+109 -0 = $283.9 million

weightage of market cap = 174.9 / (174.9 + 109) = 0.62

Weightage of Debt = 109 / (174.9 +109) = 0.38

Risk free return = 7% (treasury bond rate)

Market premium = 10% (assume)

Beta = 1.15

Cost of equity (CAPM MODEL) = 7% + 1.15*10 = 18.5 %

Cost of Debt =8.5 (1- .4) = 5.1 % [ post tax (40 %) interest rate (8.5%) ]

1. Cost of capital = 18.5* 0.62 + 5.1*0.38 = 21.06%

2. Value of the firm is the present value of all the future cash flow to the firm.

Cash Flow to Firm = EBIT (1 - tax) + depreciation - capital expenditure - working capital

Given: Depreciation = capital expenditure

Working capital = negligible

therefore, Cash flow to Firm = EBIT (1 - tax rate)

Corporate tax rate = 40%

Long term growth rate of EBIT = 4%

Terminal value = EBIT (2006) / 0.04

PARAMETERS/ PERIOD	2002	2003	2004	2005	2006	TERMINAL VALUE
EBIT	12.5	13.75	15.13	16.64	18.30
EBIT (1-TAX)	7.5	8.25	9.08	9.98	10.98	274.52
FCFF		8.25	9.08	9.98	10.98	274.52
WACC		21.06%	21.06%	21.06%	21.06%	21.06%
PV of all future cash flow		6.81	6.19	5.63	5.11	127.81

Total Present value of all future cash flow = 6.81 +6.19+5.63+5.11+127.81 = $151.56 milion

The Value of the Firm = $151.56 million

3. The equity value = Value of the Firm - debt outstanding

= $151.56 - 109

= $42.56 million

The share price = Equity value / outstanding shares

= $42.56 / 15.9

= $2.68 / share

NOTE: Since the market premium is not given, the calculated cost of capital may vary.

Therefore this share price may or may not be equal to the expected share price.

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