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

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

approx. $125

approx. $199

approx. $375

approx. $258

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

Answer 1

calculation of free cash flows:-

free cash flows = EBIT (1- tax) + depreciation - NCS - change in working capital

change in working capital = current year working capital - previous year working capital

= (6700-3000) - (5500-2200) = $ 400 millions

NCS means net capital spending that is amount thar firm spends on acquiring fixed assets during the year.

NCS formula = Fixed assets at the end of year - fixed assets at the beginning of the year + depreciation

= 27,000 - 25,000 +2500 = $ 4500 millions

free cash flows = $15,000 * (1-0.30) + $ 2500-$ 4500-$ 400 =$ 8100 millions

Calculation of weighted average cost of capital :-

Cost of equity under capm approch = Rf + Beta (Rm - Rf)

Rf= risk free rate = 3%

Rm = market risk rate = 13%

Beta = 1.50

cost of equity = 3% + 1.5 (13%-3%)= 18%

cost of debt =( interest / debt amount)*100 = ( 1300/9700) *100 = 13.4%

here debt means only long term debt

share holder equity + debt = 21,000+9700=30,700 millons

weight of debt = 9700/30700= 0.3160

weight of equity = 21,000/30700= 0.6840

weighted average cost of capital = cost of debt * weight of debt *(1-tax rate) + cost of equity * weight of equity

= 13.4% * 0.3160 * (1-0.30) + 18% * 0.6840

= 2.96%+12.31%

weighted average cost of capital =15.27%

calculation of the Fair value for galaxy interiors stock value:

Value of galaxy interiors =( cash flows* (1+g)) / (Ko -g)

here

g= growth rate of cash flows = 2.5%

Ko= weighted average cost of capital. = 15.27%

cash flows=$ 8100 millions

value of galaxy interiors = (8100 millions * 1.025) /( 0.1527 - 0.025)

= 8302.5 milloins / 0.1277

= $ 65015.66 millions

value of equity = value of firm - value of debt

value of equity = 65015.66 - 9700 = $ 55315.66 millions

fair value of galaxy interiors stock = $ 55315.66 millions