1 Stuart, Inc. reported net income of $20 million for last year. Depreciation ex
ID: 2722553 • Letter: 1
Question
1 Stuart, Inc. reported net income of $20 million for last year. Depreciation expense totaled $15 million and capital expenditures came to $5 million. Free cash flow is expected to grow at a rate of 6% for the foreseeable future. Stuart faces a 40% tax rate and has a 0.30 debt to equity ratio with $75 million (market value) in debt outstanding. Stuart's equity beta is 1.1, the risk-free rate is currently 6% and the market risk premium is estimated to be 8.0%. What is the current value (in millions) of Stuart's equity?
Explanation / Answer
The equity value can be calculated with the use of following formula:
Equity Value = Firm Value - Market Value
where Firm Value = Free Cash Flow*(1+Growth Rate)/(Required Return - Growth Rate)
where Required Return = Risk Free Rate + Beta of Asset*Market Risk Premium
where Beta of Asset = Beta of Equity/(1+Debt Equity Ratio*(1-Tax Rate))
__________
Using the information provided in the question, we get,
Beta of Asset = 1.1/(1+.30*(1-40%)) = .93
Required Return = 6 + .93*8 = 13.44%
Firm Value = (20 + 15 - 5)*(1+6%)/(13.44% - 6%) = $427.42
Equity Value = 427.42 - 75 = $352.42
Related Questions
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.