Apple currently produces annual free cash flow of 40 billion a year. The company
ID: 2773697 • Letter: A
Question
Apple currently produces annual free cash flow of 40 billion a year. The company has long-term debt of $18 billion and Cash and Marketable Securities of $150 billion. Given that the stock currently trades in the marketplace at $100 and that there are 6 billion shares outstanding, at what rate is the market factoring in for FCF growth assuming that the stock is correctly valued and that the FCF will grow constantly next year and beyond. Use a WACC of 8% for your calculation. Secondly, assume that FCF is going to grow at 7% for the next 3 years as they introduce new products and that in year 4 and beyond the FCF will grow at 1%. What is the intrinsic value of the stock given this new information? Comment on your findings.
Explanation / Answer
(a)
We know that value of business = Value of equity + value of debt
Value of business= ( 6 billion shares x 100 ) + 18 billion
Value of business = 600+18
Value of business = $618 billion.
Annual Free cash flow = $ 40 billion
Value of business = FCF in next year / ( WACC- Growth rate)
618 = 40 (1+G)/ (.08-G)
By solving this we will get
G= 1.435 %
Therefore annual growth rate for FCF = 1.435 %.
(b) Value of Business =
(Sum of discounted cash flow for year 1 to 3) + (Terminal Value at the end of year three)
Year
FCF
DF = (WACC)- Year
DCF
1
42.80 (40 x 1.07)
0.926
39.6296
2
45.796 ( 42.80 x 1.07)
0.857
39.2627
3
49.00 ( 45.796 x 1.07)
0.794
38.8991
117.791
Terminal Value at the end of year 3 = FCF for 4th year / (WACC-Growth)
Terminal Value = 49 x (1.01) / (0.08-0.01)
Terminal Value = 707.02
Business Value = 117.791 + 707.02
Business Value = 824.82
Debt Value = 18
Value of Equity = 824.82-18
Value of equity = 806.82
Intrinsic Value of share = Value of equity / Shares outstanding
Intrinsic value = $806.82 billion/ 6 billion
Intrinsic value of shares = $ 134.47
Notes/ Assumption- FCF of $40 billion is considered free cash flow to the firm.
Year
FCF
DF = (WACC)- Year
DCF
1
42.80 (40 x 1.07)
0.926
39.6296
2
45.796 ( 42.80 x 1.07)
0.857
39.2627
3
49.00 ( 45.796 x 1.07)
0.794
38.8991
117.791
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