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

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? (Do not round intermediate calculations. Enter your answer in millions rounded to 2 decimal places.) Firm value million

Explanation / Answer

Equity beta = 1.70

Debt equity ratio = 0.40

Levered beta = unlevered beta × [1 + (1 - tax rate) x (Debt/Equity)]

                      = 1.70 × [1+ (1 – 30%) × (40%)]

                      = 1.70 × [1+ 0.28]

                      = 2.176

So, Levered beta is 2.176.

Now cost of equity when debt level calculated below using CAPM model:

Cost of equity = Risk free rate + Risk Premium × Beta

= 6% + (11% × 2.176)

= 6% + 23.94%

= 29.94%

Cost of equity is 29.94%.

Now,

Free cash flow = EBIT × (1 - Tax rate) + Depreciation - Capex - Change in Working capital

= $56 × (1 - 30%) + $5.60 - $5.30 - $2.70

= $39.2 -$2.40

= $36.80 milllion.

Free cash flow of firm is $36.80 million.

Growth rate = 3%.

Value of firm = Free cash flow × (1 + growth rate) / (cost of equity - growth rate)

= $36.80 × (1 + 3%) / (29.94% - 3%)

= $37,904 / 26.94%

= $140.70 million.

Value of firm is $140.70 million.

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