Question

Lansing Corporation reported net income of $61 million for last year. Depreciation expense totaled $15 million and capital expenditures came to $6 million. Free cash flow is expected to grow at a rate of 4.7% for the foreseeable future. Lansing faces a 40% tax rate and has a 0.38 debt to equity ratio with $290 million (market value) in debt outstanding. Lansing's equity beta is 1.61, the risk-free rate is currently 5% and the market risk premium is estimated to be 6.4%. What is the current total value of Lansing's equity (in millions)?

Answer #1

First, we calculate the free cash flow. It will be = Net Income x (1-t) + Depreciation - Capital Expenditures = 61 x (1 - 0.4) + 15 - 6 = 45.6 million. Now, we will use the Gordon growth formula to calculate the equaity value:

Equity Value = FCF x (1+g)/(R - g)

Growth is known to us but not the cost of equity. The cost of equity will be calculated by the CAPM formula given as:

R = Rf + beta x (Rm - Rf) = 5 + 1.61 x 6.4 = 15.304%.

Hence, the equity value will be = 45.6 x 1.047/(0.15304 - 0.047) = $450.237 million.

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