Question

You are going to value Lauryn’s Doll Co. using the FCF model. After consulting various sources, you find that Lauryn's has a reported equity beta of 1.5, a debt-to-equity ratio of 0.3, and a tax rate of 40 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's made $4.25 million in capital expenditures and increased net working capital by $4.1 million. Assume the FCF is expected to grow at a rate of 2 percent into perpetuity. What is the value of the firm (in millions)?

Answer 1

Equity Beta = 1.50
D/E = 0.30
Tax Rate = 40%

Asset Beta = Equity Beta / [1 + (1 - tax) * (D/E)]
Asset Beta = 1.50 / [1 + (1 - 0.40) * 0.30]
Asset Beta = 1.50 / 1.18
Asset Beta = 1.27

Cost of Capital, ke = Risk-free Rate + Asset Beta * Market Risk Premium
Cost of Capital, ke = 4% + 1.27 * 12%
Cost of Capital, ke = 19.24%

Free Cash Flow, FCF0 = EBIT * (1 - tax) + Depreciation - Capital Expenditure - Increase in Net Working Capital
Free Cash Flow, FCF0 = $45 million * (1 - 0.40) + $4.5 million - $4.25 million - $4.1 million
Free Cash Flow, FCF0 = $23.15 million

Growth Rate, g = 2%

Expected Free Cash Flow, FCF1 = FCF0 * (1 + g)
Expected Free Cash Flow, FCF1 = $23.15 million * 1.02
Expected Free Cash Flow, FCF1 = $23.613 million

Value of Firm = FCF1 / (ke - g)
Value of Firm = $23.613 million / (0.1924 - 0.02)
Value of Firm = $23.613 million / 0.1724
Value of Firm = $136.97 million