Question

You are going to value Lauryn’s Doll Co. using the FCF model. After consulting various sources, you find that Lauryn has a reported equity beta of 1.5, a debt-to-equity ratio of .3, and a tax rate of 21 percent. Assume a risk-free rate of 4 percent and a market risk premium of 12 percent. Lauryn’s Doll Co. had EBIT last year of $45 million, which is net of a depreciation expense of $4.5 million. In addition, Lauryn made $4.25 million in capital expenditures and increased networking capital by $4.1 million. Assume her FCF is expected to grow at a rate of 2 percent into perpetuity. What is the value of the firm?

Answer 1

D/E ratio = 0.3. Thus weight of debt in capital = 0.3/(1+0.3) = 0.23077. Cost of debt = 4% (i.e. the risk free rate).

Weight of equity = 1-0.23077 = 0.769231. Cost of equity = risk free rate + beta*market risk premium = 4%+(1.5*12%) = 22%

We can now compute WACC and it will be = (4%*0.23077) + (22%*0.769231) = 17.846154%

FCF =( EBIT*(1-tax rate))+Depreciation - Capital expenditures - net working capital      

= (45*(1-0.21))+4.5-4.25-4.1

= 31.70

Thus value = FCF 0*(1+growth rate)/(wacc - growth) = 31.70*1.02/(17.846154%-2%)

= $204.05 million. Thus the value of the firm is $204.05 million