Lambert Corporation reported EBIT of $60 million for last year. Depreciation expense totaled $20 million and capital expenditures came to $5 million. Free cash flow is expected to grow at a rate of 4.5 percent for the foreseeable future. Lambert faces a 21 percent tax rate and has a .45 debt to equity ratio with $255 million (market value) in debt outstanding. Lambert's equity beta is 1.30, the risk-free rate is currently 5 percent, and the market risk premium is estimated to be 6.5 percent. What is the current total value of Lambert's equity (in millions)?
$655.90
$731.20
$908.89
$951.26
$1,025.95
Answer :
Here,
Asset beta = Equity beta / [ ( 1 + Debt / Equity ) * ( 1 - tax ) ]
= 1.30 / [ 1 + 0.45 *( 1 - 0.21 ) ]
= 0.9591
Required return = Risk-free return + Beta * Market risk premium
= 5% + 0.9591 * 6.5%
= 11.23%
Free Cash Flow (FCF) = Net income + Depreciation - Capital expenditure
= $60 million + $20 million - $5 million
= $75 million
Firm value = FCF * (1 + Growth rate) / (required return - Growth rate)
= $75 * ( 1 + 0.045 ) / ( 0.1123 - 0.045 )
= $ 1,164.56166
Now,
Equity value = Firm value - Debt outstanding
= $ 1,164.562 - $ 255
= $ 909.56
The answer is option (3) i.e., $908.89 which is close to $ 909.56
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