Question

In: Accounting

If there are 500 million shares outstanding, use the following information to find a fair value...

If there are 500 million shares outstanding, use the following information to find a fair value for Galaxy Interiors stock using the Free Cash Flow (FCF) model.

GALAXY INTERIORS INCOME STATEMENT

($ in millions)

NET SALES

$        35,000

COST OF GOODS SOLD

$        17,500

DEPRECIATION

$          2,500

EARNINGS BEFORE INTEREST AND TAXES (EBIT)

$        15,000

INTEREST EXPENSE

$          1,300

TAXABLE INCOME (EARNINGS BEFORE TAXES; EBT)

$        13,700

TAXES (0.30)

$          4,110

NET INCOME

$          9,590

GALAXY INTERIORS BALANCE SHEET (PAST & CURRENT)

($ IN MILLIONS)

PAST YR

CURRENT YR

PAST YR

CURRENT YR

CURRENT ASSETS

5500

6700

CURRENT LIABILITIES

2200

3000

(NET) FIXED ASSETS

25000

27000

LONG TERM DEBT

9300

9700

TOTAL ASSETS

30500

33700

TOTAL EQUITY

19000

21000

TOTAL LIAB & EQUITY

30500

33700

Also, assume the following:

  • Free cash flow (FCF) will grow at 2.5%
  • Galaxy's equity beta is 1.50
  • Risk-free rate is 3% and market return is 13%
  • Currently, Galaxy is not paying any dividends
  • Book value of total debt is equal to the market value of debt
  • further note that, FCF (Free cash flow) = EBIT*(1-t) + depreciation - NCS - change in NWC

Multiple choice answer:

approx. $125

approx. $199

approx. $375

approx. $258

The answer should be one of the 4 numbers above

Solutions

Expert Solution

FCF (Free cash flow) = EBIT*(1-t) + depreciation - NCS - change in NWC

EBIT = $ 15000

t = 0.3

Depreciation = $2500

NCS (Net capital spending) : the net spending on fixed assets (FA) = ending net FA–beginning net FA +depreciation

=27000 - 25000 + 2500

= $4500

change in NWC :Change in net working capital = ending NWC –beginning NWC

NWC = Current Asset - Current Liabilities

ending NWC = 6700 - 3000 =3700

begining NWC = 5500 - 2200 =3300

change in NWC =3700 - 3300 =$400

By appliying equation:

FCF (Free cash flow) = EBIT*(1-t) + depreciation - NCS - change in NWC

=15000 (1 - 0,3) + 2500 - 4500 - 400

=10500+2500-4500-400

FCF    =$8100 MILLION

In FCF valuation model, we need to discount the free cash flow to equity at the cost of equity (ke):

Total Equity Value = FCF
Ke − g

FCF = $8100

g = 2.5%

Ke = Cost of Equity is computed by using the Capital Asset Pricing Model (CAPM) as under:

Ke=Rf + β * (Rm-Rf)

where,

  • Rf represents the risk-free rate = 3%
  • Rm represents the market rate of return =13%
  • β – Beta represents a systematic risk = 1.5

Ke=3 + 1.5 * (13-3)

=3 + 15 = 18%

By appliying Equation

Total Equity Value = $8100 million = $52258.0645 million
18% − 2.5%

To find the intrinsic value per share, divide total equity value by total number of shares of common stock outstanding:

Intrinsic Value per Share = $52258.0645 million = $104.52
500 million

as $104.52 is nearest to the answer $125, it must be the answer


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