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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).

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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.

jeff jeffy answered 1 year ago

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