Question

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 1

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