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

		approx. $125
		approx. $199
		approx. $375
		approx. $258

Answer 1

FCFF (Free cash flow to the Firm) is the cash flow that is available to all the investors of a firm (shareholders + debt investors) after the firm has met all its expenses.

FCFE (Free cash flow to equity) is the cash flow that is available to only the shareholders of a firm once all the expenses including expense to the debt holders is taken care of.

Here we are ssupposed to find a fair value for Galaxy Interiors stock. There are 2 approches:

1. Common equity can be valued directly by using FCFE

2. Common equity can be valued indirectly by first using a FCFF model to estimate the value of the firm and then subtracting the value of non-common-stock capital (usually debt) from FCFF

Here I will be using the Approach 1.

and FCFE can be found from FCFF

= 27000-25000 = 2000

includes the current asset and current liablities. I am assuming here that cash part of current asset is 0

Increase in current asset is use of cash. Increase in current liabilities is a source of cash

= -(6700-5500)+ (3000-2200) = -1200+800 = -400

-ve sign just indicates that it is a outflow of cash.

= 10600

Its also mentioned that FCF will grow at 2.5%. As the growth rate is constant, we can use growth model to value the firm

Cost of equity r can be found using CAPM Model

= 0.03 + 1.5 (0.13-.03) = 0.18 = 18%

= 70096.77

Value of equity = Value of firm - MV of debt

Equity value = 70096.77 - 9700 = 60396.77 M

Shares outstanding = 500 M

Fair value per share = Equity value of firm / Shares outstanding = approx $125