Lantern Corporation reported net income of $55 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% for the foreseeable future. Lantern faces a 40% tax rate and has a 0.45 debt to equity ratio with $185 million (market value) in debt outstanding. Lantern's equity beta is 1.3, the risk-free rate is currently 5% and the market risk premium is estimated to be 6.5%. What is the current total value of Lantern's equity (in millions)?

Question

Quizplus · Accepted Answer

First, we need to calculate the free cash flow for last year:

Free Cash Flow = Net Income + Depreciation Expense - Capital Expenditures
Free Cash Flow = $55 million + $20 million - $5 million
Free Cash Flow = $70 million

Next, we need to calculate the current cost of equity:

Cost of Equity = Risk-Free Rate + Equity Beta * Market Risk Premium
Cost of Equity = 5% + 1.3 * 6.5%
Cost of Equity = 13.45%

Then, we can use the free cash flow and cost of equity to calculate the total value of equity:

Total Value of Equity = Free Cash Flow / (Cost of Equity - Growth Rate)
Total Value of Equity = $70 million / (13.45% - 4.5%)
Total Value of Equity = $840.95 million

Finally, we need to adjust for the debt by subtracting the market value of debt:

Total Value of Equity - Market Value of Debt
$840.95 million - $185 million = $655.95 million

Therefore, the answer is C.

Lantern Corporation Reported Net Income of $55 Million for Last