Question

You need to estimate the value of Laputa Aviation. You have the following forecasts (in millions of dollars) of its profits and of its future investments in new plant and working capital:

	Year
		1			2			3			4
Earnings before interest, taxes, depreciation, and amortization (EBITDA)	$	74		$	94		$	109		$	114
Depreciation		24			34			39			44
Pretax profit		50			60			70			70
Tax at 40%		20			24			28			28
Investment		18			21			24			26

From year 5 onward, EBITDA, depreciation, and investment are expected to remain unchanged at year-4 levels. Laputa is financed 50% by equity and 50% by debt. Its cost of equity is 17%, its debt yields 8%, and it pays corporate tax at 40%.

a. Estimate the company’s total value. (Do not round intermediate calculations. Enter your answer in millions rounded to the nearest whole amount.)

b. What is the value of Laputa’s equity? (Do not round intermediate calculations. Enter your answer in millions rounded to 2 decimal places.)

Answer 1

Answer :- (a)

Calculation of free cash flow :-

	1	2	3	4
EBITDA	74	94	109	114
less :- Depreciation	24	34	39	44
Pretax Profit	50	60	70	70
Tax @ 40 % on pre tax profit	20	24	28	28
Profit after tax	30	36	42	42
Operating Cash flow ( Depreciation + Profit after tax)	54	70	81	86
less : Investment	18	21	24	26
Free Cash Flow	36	49	57	60

Now we will calculate WACC :-

WACC = ( Weight of debt * Cost of debt after tax ) + (weight of equity * Cost of equity)

= { 0.50 * [ 8 * ( 1- 0.40 ) ] } + { 0.50 * 17 }

= { 0.50 * 4.8 } + { 0.50 * 17 }

= 2.4 + 8.50

= 10.90%

Now we will calculate Horizon Value at Year 4 :-

= FCF ( year 4 ) / WACC

= 60 / 0.1090

= 550.46

Company's Value = FCF1 / 1.109 + FCF2 / 1.1092 + FCF3 / 1.1093 + FCF4 / 1.1094​​​​​​​ + Horizon Value4 / 1.1094

= (36 / 1.109) + (49 / 1.22988) + (57 / 1.363938) + (60 / 1.51261) + (550.46 / 1.51261)

= 32.46 + 39.84 + 41.79 + 39.67 + 363.91

= 517.67

(b) Value of Laputa’s equity :-

As equity weight is 0.50 , so

Value of equity = Total Value of firm * weight of equity

= 517.67 * 0.50

= 258.835