Lockheed Corporation reported EBITDA of $4,000 million in the year just ended (year 0), prior to interest
Question:
Lockheed Corporation reported EBITDA of $4,000 million in the year just ended (year 0), prior to interest expenses of $1,000 million and depreciation charges of $600 million. Capital expenditures in the year just ended amounted to $1,000 million, and working capital was 8% of revenues (which was $20,000 million). The tax rate for the firm was 40%.
The firm had debt outstanding of $18.00 billion (in book value terms), trading at a market value of $20.0 billion and yield a pre-tax interest rate of 8%.
There were 100 million shares outstanding, trading at $250 per share, and the most recent beta was 1.20. The Treasury bond rate was 3%, and the market risk premium was 6.5%.
The firm expected revenues, earnings (EBITDA) and depreciation to grow at 10% a year from the current year (year 0) to year 3, after which the growth rate was expected to drop to 3% a year forever.
Capital expenditures will also grow at 10% a year from year 0 to year 3, but capital spending will be 120% of depreciation in the steady state period. The company also planned to lower its debt/equity ratio to 60% for the steady state which will result in the pretax interest rate dropping to 6%. As a result of the lowering of the firm’s debt/equity ratio, the beta of the firm is also expected to decline.
- Estimate the free cash flow to the firm.
Year 0 | Year 1 | Year 2 | Year 3 | Year 4 | |
Growth Rate | 10% | 10% | 10% | 10% | 3% |
EBITDA | 4,000 | ||||
Depreciation | 600 | ||||
EBIT | 3,400 | ||||
Taxes | 1360 | ||||
EBIT(1-T) | 2,040 | ||||
Capital Expenditures | 1,000 | ||||
Revenues | 20,000 | ||||
Working Capital Required | 1,600 | ||||
Change in Working Capital | -1,600 | ||||
Free Cash Flow to Firm |
- Compute the beta of the firm after Year 3.
- Determine the Cost of Equity and WACC for the Period from Year 0 to Year 3, and the Cost of Equity and WACC after Year 3.
Cost of Equity Before Year 3 =
WACC Before Year 3 =
Cost of Equity After Year 3 =
WACC After Year 3 =