Lizo is a public company with the following characteristics (in the most recent year): - At...

Lizo is a public company with the following characteristics (in the most recent year):

- At the start of the year, the firm had book value of equity of $400 million, debt outstanding (book value as well as market value) of $200 million, and cash balance of $100 million. These numbers did not change during the most recent year.
- The cost of capital for the firm is 6% next year, 8% the year after and 9% thereafter (in perpetuity).
- Shares outstanding: 200 million
- After-tax operating income: $100 million
- Revenues: $800 million

a) Lizo’s after-tax operating income is expected to grow 20% in each of the next 3 years. You expect Lizo to maintain its current return on invested capital (ROIC) forever. Estimate the free cash flows to the firm in each of the next 3 years.

b) At the end of year 3, you expect Lizo to be in stable growth, growing 5% a year in perpetuity, while maintaining its current return on invested capital. Estimate the terminal value at the end of year 3.

c) Estimate the market value of equity today.

d) Lizo has 50 million options outstanding. Assume that the market value of each option is $5. Using the “market value approach”, estimate the value per share for Lizo today.

Expert Solution

Answer for Question (a)

	Year 0	Year 1	Year 2	Year 3
Net Profits	100	120	144	173
Equity	400	480	576	691
ROIC	25%	25%	25%	25%
Debt (50% of equity)	200	240	288	346

Net profits	100	120	144	173
Increase in equity		80	96	115
Increase in Debt		40	48	58
Free cash flow		240	288	346
PV of Free cash flow		226	247	267

Explanation:-

The net profit is increased by 20% for all the years

The PV (Present value) of future cash flow is arrived by using the cost of capital of the firm for respective three years (i.e 6%, 8% and 9%).

The debt to equity ratio is maintained throughout the three years.

There is no change in ROIC (Return on capital invested)

1 question is answered.

ekkarill92 answered 1 year ago

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