Goog company has an EBIT*(1-tax) of $9,737, a depreciation of $1,851, change of

Question

Goog company has an EBIT*(1-tax) of $9,737, a depreciation of $1,851, change of NWC of $381, and a capital expenditure of $3,438. The growth rate of free cash flow is expected to be 17.68% for next two years. The beta of the firm is 1.19, the target capital structure of the firm is 6% debt 94% equity, the cost of debt is 3%, the tax rate is 40%, the market risk premium is 8% and the risk free rate is 1%. Given a comparable Price to Ebitda ratio of 14.15 and a market value of debt of $4,200, what is firm’s equity value using the FCFF approach?

A.

$138,792

B.

$214,190

C.

$102,120

D.

$360,012

Please Explain.

A.

$138,792

B.

$214,190

C.

$102,120

D.

$360,012

Explanation / Answer

We nned to arrice at the free cash flow first hence free cash flow = EBIT(1-T) + depreciation - change in NOW - capital expensiture

= 9737 +1851-381-3438 = 7769

Now we nned to compute the cost of equity using the CAPm model

Ke = Rf + beta (Rm - Rf)

Ke = .01 + 1.19 (.08)

Ke = 10.52%

Kd = 3% ( 1- taxrate) = 3%(1-.4) = 3% *.6 = 1.8%

to discount he free cash flow w enned to arrive at the cost of capital

Hence cost of capital = cost of equity * weights + cost of debts * weights

= 10.52%*.94 + 1.8% * .06

= .0988 + .00108

= 9.988% is the cost of capital

Using the discounted cash flow approach the value of the equity would be :

Year 1 the cash flow = 7769*1.1768 = 9142.55

Year 2 cash flow = 9142.55*1.1768 = 10759

To arrive at the price = 14.15 % * EBITDA

EBITDA = 9737/.6 + 1851

= 18079

Hence price = 18079*.1415

= 2558.17

Market value of equity + debt - cash = 2558.17

hence value of equity = 2558 + 7769 - 4200

= 6127

Hence we willl discount the cash flow for year 1 and year 2 and get the result

Terminal value after year 2 = 10759/.09988

= 107719

Discounted we get = 9142* (1/1.09988^1) = 8311

2nd year = 10759* (1/1.09988^2)= 8893

Terminal discounted = 107719 * ( 1/1.0988^2) =89046

hence the value of equity = 89046+8893+8311 - 4200

= 102,050

It is 102,050 because of rounding off; if you take another two decimals you will get exactly 102,120

so option C is correct answer.

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