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

Solution:

Cost of equity=Risk free rate+(equity beta×market risk premium )

=4%+(1.5*12%)

=22%

After tax cost of debt= risk free rate(1-tax rate)

=4%(1-0.21)=3.16%

Debt to equity ratio=0.30

Total capital=1.30

Weight of debt=0.3/1.3=0.2308

Weight of equity=1-0.2308=0.7692

WACC=Cost of equity*weight of equity+after tax cost of debt*weight of debt

=22%*0.7692+3.16%*0.2308

=17.6517%

Free cash flow=EBIT(1-TAX RATE)+Depreciation-Change in working capital-Capital expenditure

=$45 million(1-0.21)+$4.5 million-$4.1million-$4.25 million

=$31.70 million

Value of the firm is;

=Free cash flow(1+growth rate)/(Wacc-growth rate)

=$31.70 million(1+0.02)/(17.6517%-2%)

=$202.53 million