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 percent for the foreseeable future. Lambert faces a 21 percent tax rate and has a .45 debt to equity ratio with $255 million (market value)in debt outstanding. Lambert's equity beta is 1.30, the risk-free rate is currently 5 percent, and the market risk premium is estimated to be 6.5 percent. What is the current total value of Lambert's equity (in millions)?

Question

Quizplus · Accepted Answer

First, we need to calculate the free cash flow for last year:
FCF = EBIT - taxes + depreciation - capital expenditures
FCF = $60 million - (0.21 x $60 million) + $20 million - $5 million = $52.4 million

Next, we need to calculate the weighted average cost of capital (WACC):
WACC = (E/V x Re) + ((D/V x Rd) x (1 - corporate tax rate))
where E is the market value of equity, V = E + D is the sum of the market value of equity and debt, Re is the cost of equity, D is the market value of debt, Rd is the cost of debt, and the corporate tax rate is 21%.

To calculate Re, we can use the capital asset pricing model (CAPM):
Re = Rf + β x (Rm - Rf)
where Rf is the risk-free rate, β is the equity beta, and Rm is the market risk premium.

Re = 5% + 1.30 x 6.5% = 13.45%

To calculate Rd, we can use the yield to maturity on Lambert's outstanding debt:
Assuming the yield to maturity is 7%, then Rd = 7%

Next, we can calculate the market value of equity:
V = E + D
0.45E = $255 million
E = $566.67 million
V = $566.67 million + $255 million = $821.67 million

WACC = (0.6916 x 13.45%) + (0.3084 x 7% x (1 - 0.21))
WACC = 9.53%

Finally, we can use the Gordon growth model to calculate the current total value of Lambert's equity:
V = FCF × (1 + g) ÷ (WACC - g)
where g is the expected growth rate in free cash flow.

V = $52.4 million × (1 + 4.5%) ÷ (9.53% - 4.5%)
V = $908.89 million

Therefore, the current total value of Lambert's equity is $908.89 million (option C).

Lambert Corporation Reported EBIT of $60 Million for Last Year