Howard Co had EBITDA of $100 million in the trailing 12 months. It expects EBITD

Question

Howard Co had EBITDA of $100 million in the trailing 12 months. It expects EBITDA to increase at 10%/year for the next 2 years .Assume a terminal value for the enterprise to be 6 * year 2 EBITDA in all cases. The target D/E ratio for the industry is 1/3. Other facts about Howard are: tax rate = 40%; capex = depreciation = $20 million /year forever; long term debt = $150 million that will be rolled over indefinitely. Assume Howard cost of debt = 8% pretax. The risk free rate is 4% and the expected return on the market is 9%. Howard’s cost of equity assuming target D/E is 12%.

Calculate FCF each year for the 2 year discrete period and the residual value as of the end of the second year.

Calculate the appropriate WACC

Calculate the value of Howard equity using the FCF/WACC approach

Explanation / Answer

1)1year EBITDA =100 *110% = $ 110

EBITDA -Depreciation -Interest =EBT

110-20-12 = 78 -78*40% = 46.80

free cash flow =Net income +depreciation - capex

                   = 46.80 +20-20 = 46.80

2 year EBITDA =110*110%   = $121

121-20-12 = 89

89-89*40% = 53.40

Free cash flow = 53.40+20-20 =53.40

Residual value end of second year = 6*121 = $726 million

2)Wacc =After tax cost of debt *weight of debt +cost of equity * weight of equity

       =8(1-.40)*1/3 +12*2/3

      =4.80*1/3 + 8

       =1.6+ 8

         = 9.60 %

3)Value of Howard co equity = free cash flow of 1 year /(1+wacc)^1 + free cash flow of 2 year / (1+wacc) ^2

                                        = 46.80 /(1+.096)^1 +53.40 /(1+.096)^2

                                         = 46.80/1.096 + 53.40/1.2012

                                        =42.70+44.46

                                           = $87.16 million

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