Beach & Company reported EBIT of $40 million for last year. Depreciation expense totaled $18 million and capital expenditures came to $8 million. Free cash flow is expected to grow at a rate of 5 rate for the foreseeable future. Beach faces a 21 percent tax rate and has a .50 debt to equity ratio with $200 million (market value)in debt outstanding. Beach's equity beta is 1.25, the risk-free rate is currently 4.5 rate and the market risk premium is estimated to be 8 percent. What is the current total value of Beach & Company (in millions)?

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Quizplus · Accepted Answer

First, calculate the unlevered free cash flow (UFCF):$$ \text{UFCF} = \text{EBIT} \times (1 - \text{Tax Rate}) + \text{Depreciation} - \text{Capital Expenditures} $$$$ \text{UFCF} = \$40M \times (1 - 0.21) + \$18M - \$8M = \$31.6M + \$18M - \$8M = \$41.6M $$Next, calculate the WACC (Weighted Average Cost of Capital):$$ \text{Equity Value} = \text{Debt Value} / \text{Debt to Equity Ratio} = \$200M / 0.5 = \$400M $$$$ \text{Total Value} = \text{Debt Value} + \text{Equity Value} = \$200M + \$400M = \$600M $$$$ \text{Equity Cost} = \text{Risk-Free Rate} + \text{Equity Beta} \times \text{Market Risk Premium} = 4.5\% + 1.25 \times 8\% = 14.5\% $$$$ \text{Cost of Debt} = \text{Risk-Free Rate} + \text{Debt Premium} $$Assuming the cost of debt is close to the risk-free rate due to lack of information about the debt premium, we use the risk-free rate for simplicity.$$ \text{WACC} = \frac{\text{Equity Value}}{\text{Total Value}} \times \text{Equity Cost} + \frac{\text{Debt Value}}{\text{Total Value}} \times \text{Cost of Debt} \times (1 - \text{Tax Rate}) $$$$ \text{WACC} = \frac{\$400M}{\$600M} \times 14.5\% + \frac{\$200M}{\$600M} \times 4.5\% \times (1 - 0.21) $$$$ \text{WACC} \approx 10.3\% $$Finally, calculate the total value using the Gordon Growth Model since the free cash flow is expected to grow at a constant rate:$$ \text{Total Value} = \frac{\text{UFCF} \times (1 + \text{Growth Rate})}{\text{WACC} - \text{Growth Rate}} $$$$ \text{Total Value} = \frac{\$41.6M \times (1 + 5\%)}{10.3\% - 5\%} $$$$ \text{Total Value} = \frac{\$41.6M \times 1.05}{0.053} \approx \$787.29M $$Therefore, the current total value of Beach & Company is approximately $787.29 million.

Beach & Company Reported EBIT of $40 Million for Last