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 firms debt/equity ratio, the beta of the firm is also expected to decline.

1. Estimate the free cash flow to the firm. (40pts)

	Year 0	Year 1	Year 2	Year 3	Year 4
Growth Rate
EBITDA
Depreciation
EBIT
Taxes
EBIT(1-T)
Capital Expenditures
Revenues
Working Capital Required
Change in Working Capital
Free Cash Flow to Firm

2. Compute the beta of the firm after Year 3. (4pts)

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. (16pts)

Cost of Equity Before Year 3 =

WACC Before Year 3 =

Cost of Equity After Year 3 =

WACC After Year 3 =

4. Estimate the Terminal Value of the Firm in Year 3. (3pts)

5. List the free cash flows to the firm (FCFF). FCFF in Year 3 should include the terminal value. (3pts)

Year	1	2	3
Free Cash Flow to Firm

6. Estimate the Enterprise Value of Lockheed (value of the firm). (4pts)

7. Lockheed has $800 million in cash, and it also owns 10% of the stock of ABC Corporation. ABC Corporation has 100 million shares outstanding, and its shares are trading at $50/share. Estimate the Market Value of Equity, and estimate the current share price of Lockheed. (6pts)

(Hint: Solve for the value of equity from the following relation:

Enterprise Value = Market Value of Equity + Market Value of Debt Cash & Investments)

8. Briefly explain your recommendation for the stock of the company. (4pts)