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 .4, and a tax rate of 21 percent. Assume a risk-free rate of 4 percent and a market risk premium of 8 percent. Lauryn’s Doll Co. had EBIT last year of $41 million, which is net of a depreciation expense of $4.1 million. In addition, Lauryn's made $4 million in capital expenditures and increased net working capital by $2.0 million. Assume the FCF is expected to grow at a rate of 2 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

Solution;

Calculation of value of the firm:

a)Free cash flow=EBIT(1- Tax rate)+Depreciation-change in working capita-Capital expenditure

=$41million(1-0.21)+$4.1 million-$2million-$4 million

=$30.49 million

b)Cost of equity=risk free rate+beta*market risk premium

=4%+(1.4*8%)

=15.2%

After tax cost of debt=risk free rate(1-tax rate)

=4%(1-0.21)=3.16%

D/E=0.4,thus total capital is 1.4

Weight of equity=1÷1.4

Weight of debt=0.4÷1.4

WACC=Cost of equity*weight of equity+after tax cost of debt*weight of debt

=(15.2%×1/1.4)+(3.16%*0.4/1.4)

=11.76%

Value of the firm=[Free cash flow(1+growth rate)]/WACC-growth rate

=[$30.49 millio(1+0.02)]/(11.76%-2%)

=$318.65 million