Question

Next year, Flying Cow is expected to earn an EBIT of $10,000,000, and to pay a federal-plus-state tax rate of 35%. It also expects to make $2,500,000 in new capital expenditures to support this level of business activity, as well as $50,000 in additional net operating working capital (NOWC).

Given these expectations, it is reasonable to conclude that next year Flying Cow will generate an annual free cash flow (FCF) of      (rounded to the nearest whole dollar).

Next, based on your estimate of Flying Cow’s next year’s FCF and making the stated assumptions, complete the following table:

•	Flying Cow can sustain this annual FCF forever,
•	the company has a weighted average cost of capital of 17.10%,
•	the company does not currently own any marketable securities,
•	there are 75,000 shares of Flying Cow outstanding
•	the company’s value of debt is 45% of its total entity value, and
•	the company’s value of preferred shares is 25% of its total entity value.

Attributes of Flying Cow	Value
Total Entity Value
Value of Common Equity
Intrinsic value (per share)

Answer 1

1. Free Cash flow = EBIT * (1 - Tax) - Capital spending - Addition to working capital

Free Cash flow = 10000000* (1 - 35%) - 2500000 - 50000

Free Cash flow = $3950000

2. Total entity value = Free cash flow / cost of capital

Total entity value = 3950000 / 17.10%

Total entity value = $23099415.20

3. Value of common equity = Entity value * (1 - Weight of debt - weight of preferred stock)

Value of common equity = 23099415.20 * (1 - 45% - 25%)

Value of common equity = $6929824.56

4. Intrinsic value per share = Value of Common equity / Shares O/s

Intrinsic value per share = 6929824.56 / 75000

Intrinsic value per share = $92.40