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Lantern Corporation reported EBIT of $75 million for last year
Lantern Corporation reported EBIT of $75 million for last year. Depreciation expense totaled $22 million, capital expenditures came to $6 million, and net working capital increased by $3 million. Free cash flow is expected to grow at a rate of 5% for the foreseeable future. Lantern faces a 40% tax rate and has a 0.45 debt to equity ratio with $190 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%.
Based on the information, what is Lantern's asset beta?
Using your answer to the previous question a), calculate the appropriate discount rate.
What is Lantern's FCF for the year?
What is the current total value of Lantern's equity (in millions)? (5 points)
What is the fair value of Lantern's per share if it has 100 million shares of outstanding?
Expert Solution
Given,
Total Market Value of Lantern Corporation = $185 million
Debt + Equity = $190 million
Debt = $190 million - Equity
Debt to Equity Ratio = 0.45
Debt / Equity = 0.45
Debt = 0.45 * Equity
$190 million - Equity = 0.45 Equity
1.45 Equity = $190 million
Equity = $190 milllion / 1.45
Equity = $131.03 million
Debt = $190 million - Equity
= $190 million - $131.03 million
Debt = $58.97 million
Calculation of Lantern's Asset Beta :
Asset Beta = Equity Beta / (1+ (1- Tax Rate) * (Total Debt / Total Equity)))
Given,
Equity Beta = 1.3
Tax rate = 40%
Now Asset Beta = 1.3 / (1+ (1-0.40) * ($58.97 / 131.03)))
= 1.3 / (1+ 0.27)
Asset Beta = 1.02
Calculation of Discount rate :
Given,
Risk free rate (Rf) = 5%
Market Risk Premium (Km) = 6.5%
Asset Beta = 1.02
Adjusted Discounted Rate (Kc) = Rf + beta * (Rm - Rf)
= 5% + 1.02 * (6.5% - 5%)
= 5% + 1.54%
Adjusted Discounted Rate Kc = 6.54%
Calculation of Lantern's FCF for the Year :
Free Cash Flows = Net Income + Depreciation - Capital Expenditure - Working capital + Interest Expenses*(1- Tax Rate)
Given,
EBIT = $75 million
Net Income / (1- Tax Rate ) + Interest Expenses = $75 million
Net Income / 0.60 + $58.97 million * 5% = $75 million
Net Income =( $75 million- $2.95 million) * 0.60
Net Income = $43.23 million
Now FCF = $43.23 million + $22 million - $6 million - $3 million + $58.97 *5% (1-0.40)
= $56.23 million +$1.77 million
FCF for the year = $58 million
Calculation of Lantern's Fair value per share :
Return on Capital Employed = EBIT * (1- Tax Rate) / (Book Value of Debt + Book Value of Equity)
= $75 million * 0.60 / $190 million
= 23.68%
Discounted Rate = 6.54%
Given FCF constant growth rate = 5%
Therefore Total Value of Lantern's Corporation = FCF / (k- g)
Where k = Disounted rate
g = constant growth rate
= $58 million / (6.54% - 5%)
= $58 million / 1.54%
Total Value of the Company = $3,777.44 million
Total Value of Equity = Total Value of the Company - market value of the Debt
= $3,777.44 million - $58.97 million
= $3,718.47 million
Given total number of shares = 100 million
Therefore fair Value of Equity Share = $3,718.47 million / 100 million
= $37.18 per share
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