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 1.7, a debt-to-equity ratio of 0.4, and a tax rate of 30 percent. Assume a risk-free rate of 6 percent and a market risk premium of 11 percent. Lauryn’s Doll Co. had EBIT last year of $56 million, which is net of a depreciation expense of $5.6 million. In addition, Lauryn's made $5.3 million in capital expenditures and increased net working capital by $2.7 million. Assume the FCF is expected to grow at a rate of 3 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.)

Answer 1

Calculation of Asset Beta:

Asset Beta = Equity Beta / [1 + (1 - Tax) * Debt-Equity Ratio]
Asset Beta = 1.70 / [1 + (1 - 0.30) * 0.40]
Asset Beta = 1.70 / 1.28
Asset Beta = 1.33

Calculation of Cost of Capital:

Cost of Capital = Risk-free Rate + Asset Beta * Market Risk Premium
Cost of Capital = 6.00% + 1.33 * 11.00%
Cost of Capital = 20.63%

Calculation of Last Year’s Free Cash Flow:

Free Cash Flow, FCF0 = EBIT * (1 - Tax) + Depreciation - Capital Expenditure - Increase in NWC
Free Cash Flow, FCF0 = $56 million * (1 - 0.30) + $5.60 million - $5.30 million - $2.70 million
Free Cash Flow, FCF0 = $36.80 million

Calculation of Next Year’s Free Cash Flow:

Expected Free Cash Flow, FCF1 = FCF0 * (1 + g)
Expected Free Cash Flow, FCF1 = $36.80 million * 1.03
Expected Free Cash Flow, FCF1 = $37.90 million

Calculation of Value of Firm:

Value of Firm = FCF1 / (Cost of Capital - Growth Rate)
Value of Firm = $37.90 million / (0.2063 - 0.03)
Value of Firm = $214.97 million