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 1.7, a debt-to-equity ratio of 0.4, and a tax rate of 30 percent. Assume a risk-free rate of 6 percent and a market risk premium of 11 percent. Lauryn’s Doll Co. had EBIT last year of $56 million, which is net of a depreciation expense of $5.6 million. In addition, Lauryn's made $5.3 million in capital expenditures and increased net working capital by $2.7 million. Assume the FCF is expected to grow at a rate of 3 percent into perpetuity. What is the value of the firm

Answer 1

Answer:

Value of the company is $140.70

Explanation:

We need first of all turn the equity beta from an unlevered to a levered beta with the below formula:

BU = BL / [1 + ((1 - Tax Rate) x Debt/Equity)]

BL=BU*[1 + ((1 - Tax Rate) x Debt/Equity)]

BU is levered beta

BL is the levered beta which is unknown

tax rate is 30% or 0.3

debt/equity =0.4

BU is 1.7

BL=1.7*[1 + ((1 - 0.3) x 0.4)

BL=1.7*(1+(0.7*0.4)

BL=1.7*(1+0.28)

BL=1.7*1.28

BL=2.176

Cost of equity=Rf+beta*market risk premium

Rf is the risk free rate of 6%

market risk premium is 11%

cost of equity=6%+2.176*11%

cost of equity=6%+23.94%

cost of equity =29.94%

In valuing the company the stock price formula below can be adapted

stock price=Do*(1+g)/(r-g)

Do is the dividend but can be replaced with a proxy free cash flow,since dividend per share is meant to compute price of one share,but FCF is to calculate the value of the entire company.

The free cash flow is computed below

FCF=EBIT*(1-t)+depreciation and amortization-capital expenditure-net increase in working capital

FCF=$56*(1-0.3)+$5.6-$5.3-$2.7

FCF=$36.8 million

g is the growth rate of FCF at 3%

r is the cost of equity of 29.94%

value of the company=$36.80*(1+3%)/(29.94%-3%)

value of the company=$36.80*1.03/0.2694

                                     =$140.70