Question

1. 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 1.4, a debt-to-equity ratio of .3, and a tax rate of

30 percent. Based on this information, what is Lauryn’s asset beta?

          1.4 = BAsset x (1 + .3(1-.30))

          BAsset = 1.16

2. Using your answer to the previous question, calculate the appropriate discount rate assuming a risk-free rate of 4 percent and a market risk premium of 7 percent.

          Discount Rate = Risk Free Rate + (Beta x Market Risk Premium)

          Discount Rate = 4% + (1.16 x 7%)

          Discount Rate = 12.12%

3. Lauryn’s Doll Co. had EBIT last year of $40 million, which is net of a depreciation expense of

$4 million. In addition, Lauryn had a capital spending of $8 million. Using the information from

Problem 1, what is Lauryn’s FCF for the year?

          FCF = $40 + $4 - $8 = $36 Million

4. Using your answers from Questions 1 through 3, value Lauryn’s Doll Co. assuming her FCF is

expected to grow at a rate of 3 percent into perpetuity. Is this value the value of the equity?

          Firm Value = FCF (1+g) / R – G

          Firm Value = 36 (1 + .03) / (.121 - .03)

            Firm Value = $407.47

I need help with the last part of question (4).

Answer 1

Here you are using the correct formula to calculate Firm Value, but you are wrongly calculating FCF.

The correct formula for calculating FCF is:

FCF = EBIT*(1-tax)+Depreciation-capex

FCF = $40*(1-0.30)+$4-$8

FCF = $24 million.

Now, Firm Value = FCF (1+g) / (R-G)

Firm Value = 24 (1+0.03) / (0.121 - 0.03)

Firm Value = $271.65 million