Stuart, Inc. reported net income of $20 million for last year. Depreciation expe
ID: 2783459 • Letter: S
Question
Stuart, Inc. reported net income of $20 million for last year. Depreciation expense totaled $15 million and capital expenditures came to $5 million. Free cash flow is expected to grow at a rate of 6% for the foreseeable future. Stuart faces a 40% tax rate and has a 0.30 debt to equity ratio with $75 million (market value) in debt outstanding. Stuart's equity beta is 1.1, the risk-free rate is currently 6% and the market risk premium is estimated to be 8%. What is the current value (in millions) of Stuart's equity?
This was all the information given.
Explanation / Answer
Cost of equity, ke = Rf + beta x MRP = 6% + 1.1 x 8% = 14.8%
Cost of debt, kd = Risk-free rate = 6%
WACC = wd x kd x (1 - tax) + we x ke
= 0.3 / (1 + 0.3) x 6% x (1 - 40%) + 1 / (1 + 0.3) x 14.8%
= 12.22%
Free cash flow, FCF = Net Income + Depreciation - Capex = 20 + 15 - 5 = 30m
Value of firm = FCF x (1 + g) / (WACC - g)
= 30 x 1.06 / (12.22% - 6%)
= 511.6 million
Value of equity = Firm Value - Debt = 511.6 - 75 = $436.63 million