Question

Lambert Corporation reported EBIT of $60 million for last year. Depreciation expense totaled $20 million and capital expenditures came to $5 million. Free cash flow is expected to grow at a rate of 4.5% for the foreseeable future. Lambert faces a 40% tax rate and has a 0.45 debt to equity ratio with $185 million (market value) in debt outstanding. Lambert's equity beta is 1.25, the risk-free rate is currently 5% and the market risk premium is estimated to be 6.5%. What is the current total value of Lambert's equity (in millions)?

Answer 1

The current total value of Lambert's equity is calculated as $406.01 million using the Free Cash Flow to Equity method and the Capital Asset Pricing Model for estimating the cost of equity.

Step-by-step explanation:

To calculate the current total value of Lambert's equity, we shall use the Free Cash Flow to Equity (FCFE) valuation model, which requires us to first compute the FCFE. Lambert Corporation's EBIT of $60 million is taxed at 40%, leaving $36 million (EBIT(1-T)). We then account for non-cash charges and investments, adding back depreciation ($20 million) and subtracting capital expenditures ($5 million). Therefore, the FCFE before adjusting for debt is $36 million + $20 million - $5 million = $51 million.

Given that Lambert has a debt to equity ratio of 0.45, we can assume the changes in debt are in proportion with equity. Since the cost of debt is not mentioned, we will not make further adjustments regarding debt financing to the FCFE. Thus, the present value of future FCFE can be calculated using the Gordon Growth Model:

Value of Equity = FCFE / (Cost of Equity - Growth Rate)

First, we need to calculate the cost of equity using the Capital Asset Pricing Model (CAPM):

Cost of Equity = Risk-Free Rate + (Equity Beta * Market Risk Premium)

Cost of Equity = 5% + (1.25 * 6.5%) = 13.125%

Now, we can find the present value of Lambert's equity:

Value of Equity = $51 million / (13.125% - 4.5%)

Value of Equity = $51 million / 8.625% = $591.01 million (rounded to nearest million)

To find the total value of Lambert's equity, we must subtract the market value of the company's debt:

Total Equity Value = Value of Equity - Market Value of Debt

Total Equity Value = $591.01 million - $185 million

Total Equity Value = $406.01 million (rounded to nearest million)

Answer 2

$587.39

Step-by-step explanation:

Value of equity can be determined by calculating the value of the firm.

We need to calculate free cash flow first

EBIT $60 million

Less: Tax 40% $24 million

NOPAT $36 million

Add: Depreciation $20 million

Less: Capital Expenditure $5 million

Free cash flow $51 million

Now calculate the required rate of return

Levered Beta = 1.25 / (1 + (0.45) x (1-40%)) = 0.98

Required Return = Rf + Beta ( Risk Premium )

Required Return = 5% + 0.98 ( 6.5% )

Required Return = 11.4%

Value of Operation = $51 x ( 1 + 4.5%) / (11.4% - 4.5%) = $772,39

Debt = $185

As we know net asset value is the value of equity og the firm which can be calculated by deducting debt from total value of the firm.

Value of Equity = $772..39 - $185 = $587.39