Question

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

Answer 1

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