A company has EAT, depreciation expense, capital expenses, debt and debt princip

Question

A company has EAT, depreciation expense, capital expenses, debt and debt principal payments of $9m, $2.8m, $1.3m, $40m and $1.5m respectively. Between the first and the second years, it has current assets of $11m and $13.4m and current debts of $5m and $6.1m respectively. Its unlevered bheta, D/E and t are 3, 40/60 and .4 respectively. The t bond rate is 2% and the risk premium is 8% and its sales are $90m. The Company plows about 30% of its profits back into its business. Derive the value of The company.

Explanation / Answer

EAT = $ 9 Million

Depreciation =$ 2.8 Million

Capital Expenses = $ 1.3 Million

Debt = $ 40 Million

Debt Principal Payments = $ 1.5 Million

Current Assets in Year 1 = $ 11 Million

Current Assets in year 2 = $ 13.4 Million

Current Liabilities in year 1 = $ 5 Million

Current Liabilities in year 2 = $ 6 Million

Change in Current assets = CA in year 2 – CA in year 1 = $ 13.4 Million -$ 11 Million

                                               = $ 2.4 Million

Change in current liabilities =CL in year 2 – CL in year 1 = $ 6 Million - $ 5 Million =$ 1 Million

Change in Working capital = Increase in Current Assets - Increase in Current Liabilities

                                                  = $ 2.4 Million - $ 1 Million = $ 1.4 Million

Free Cash Flows = Net Income + Depreciation – Capital Expenditure – Change in Working Capital

Free Cash Flows to Equity = $ 9 Million + $ 2.8 Million - $ 1.3 Million - $ 1.4 Million

                               = $ 9.1 Million

Free Cash Flows to Firm = Free Cash Flows + Principal repayments = $ 9.1 Million + $ 1.5 Million

                                            = $ 10.6 Million  

Unlevered Beta = 3

Debt/Equity Ratio = 40/60

Tax rate = 40% or 0.4

Debt / Equity ratio = 40/60

$ 40 Million / Equity   = 40/60

Equity = $ 40 Million / (40/60)   = $ 40 Million * 60/40 = $ 60 Million

Net Income = EAT = $ 9 Million

Return Equity = $9 Million / $ 60 Million = 0.15 or 15%

Sales of the firm = $ 90 Million

Profit Margin = Net Income / Sales   = $ 9 Million / $ 90 Million = 0.10 or 10%

Plough back ratio = 30% or 0.30

Sustainable growth rate of the firm = Profit Margin * plough back ratio = 0.10 * 0.30

                                                                 = 0.03 or 3%

Total Value of the Firm = Debt + Equity + Cash   = $ 40 Million + $ 60$ Million + $ 9.1 Million

                                          = $ 109.1 Million

Cash as a % of firm value = $ 91 Million / $ 109.1 Million = 0.0834

Unlevered Beta without cash = Unlevered beta * (1-cash balance as % of firm value)

Unlevered Beta without cash = 3 * (1-0.0834) = 3* 0.9166 = 2.7498

Levered Beta = Unlevered Beta without cash * (1+((1-tax rate)*Debt/Equity)))

Levered Beta = 2.7498 * (1+((1- 0.40)*(40/60)))

Levered Beta = 2.7498 * (1+(0.6 * 40/60))

Levered Beta = 2.7498 * (1+0.40) = 3.84972 or 3.85

t-bond rate = 2%

risk premium = 8%

Expected cost of equity = t-bond rate + beta * risk premium

                                            = 2% + 3.85 * 8% = 32.80

Value of Equity = Free Cash Flows / (Cost of Equity – growth rate)

                             = $ 10.6 Million / (0.15 – 0.03)

                             = $ 10.6 Million / 0.12 = $ 83.33 Million

Value of the firm = Value of Equity + Value of Debt + Cash Balance

                                  = $ 83.33 Million + $ 40 Million + $ 10.6 Million

                                   = $ 133.93 Million

Related Questions

Navigate

• Browse (All)
• Browse A
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.