You are going to value Lauryn’s Doll Co. using the FCF model. After consulting v

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 .7, and a tax rate of 40 percent. Assume a risk-free rate of 5 percent and a market risk premium of 10 percent. Lauryn’s Doll Co. had EBIT last year of $49 million, which is net of a depreciation expense of $4.9 million. In addition, Lauryn made $4.5 million in capital expenditures and increased net working capital by $2.2 million. Assume her FCF is expected to grow at a rate of 2 percent into perpetuity. What is the value of the firm?

Explanation / Answer

First, we need ti calculate the discount rate or WACC

The D/E = 0.7 So if E = 1, D =0.7

Weight of debrt = Wd = 0.7/1.7 = 0.4118

Weight of equity = We = 1/1.7 = 0.5882

Cost of equity = Re =Rf + beta* Market Premium = 5 + 1.5* 10 = 20%

Cost of debt (pretax) = 5% (Risk free rate) . So post tax cost of debt=Rd = 5*(1-0.4) = 3%

So WACC = We*Re + Wd* Rd = 0.5882*20 + 0.4118*3 = 12.9994 = 13%

Cost of Capital = 13%

Now The cash flow for last year is calculated as shown the table below:

Cash flow this year = 49,400,000*1.02 =50,388,000

Cash flow next year = 50,388,000 *1.02 = 51,395,760

So Value of the firm in perpetuity = Cash flow next year/(r-g) where r = 13% and g = 2%

So Value of the firm = 51,395,760/(0.13-0.02) = $467,234,181.82

Cah flow last year EBIT 49000000 Less:Capital Expenditure -4500000 Less:Increase In working capital -2200000 Add back dpereciation 4900000 FCF 49400000

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