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1151416670's Question
Math
Posted 5 months ago
What is Galt's free cash flow to equity (FCFE)?
Galt Industries is expected to generate free cash flows of 24millionperyear.Galthaspermanentdebtof24 million per year. Galt has permanent debt of 
80 million, a corporate tax rate of 21%, and an unlevered cost of capital of 12% and its cost of debt capital 
is 6%.
8. What is Galt's free cash flow to equity (FCFE)?
9. What is Galt’s Cost of Equity?
10. If the Debt-Equity ratio Goes up by 1% what is the percentage change in Cost of Equity capital?
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Answer from Sia
Posted 5 months ago
Solution by Steps
step 1
To calculate Galt's free cash flow to equity (FCFE), we use the formula: FCFE=FCF−(Interest×(1−TaxRate)) FCFE = FCF - (Interest \times (1 - Tax Rate)) . Given that the free cash flow (FCF) is $24 million, the interest expense is calculated as \( Interest = Debt \times Cost\ of\ Debt = 80\ million \times 0.06 = 4.8\ million \). Thus, \( FCFE = 24 - (4.8 \times (1 - 0.21)) \)
step 2
Calculating the after-tax interest: 4.8×(1−0.21)=4.8×0.79=3.792 million 4.8 \times (1 - 0.21) = 4.8 \times 0.79 = 3.792\ million . Therefore, FCFE=24−3.792=20.208 million FCFE = 24 - 3.792 = 20.208\ million
step 3
Galt's cost of equity can be calculated using the Modigliani-Miller Proposition II with taxes: Cost of Equity=Cost of Debt+(Cost of Debt−Cost of Equity)×DE Cost\ of\ Equity = Cost\ of\ Debt + (Cost\ of\ Debt - Cost\ of\ Equity) \times \frac{D}{E} . First, we need to find E E (equity) using E=Total Assets−Debt=80+24−4.8=99.2 million E = Total\ Assets - Debt = 80 + 24 - 4.8 = 99.2\ million . The debt-equity ratio DE=8099.2 \frac{D}{E} = \frac{80}{99.2}
step 4
Now substituting into the formula: Cost of Equity=0.06+(0.06−0.12)×8099.2 Cost\ of\ Equity = 0.06 + (0.06 - 0.12) \times \frac{80}{99.2} . Calculating 8099.2≈0.805 \frac{80}{99.2} \approx 0.805 , we find Cost of Equity=0.06−0.0483≈0.0117 Cost\ of\ Equity = 0.06 - 0.0483 \approx 0.0117 or 1.17%
step 5
To find the percentage change in cost of equity capital when the debt-equity ratio increases by 1%, we first calculate the new debt-equity ratio DE+0.01 \frac{D}{E} + 0.01 . The new cost of equity can be calculated similarly, and the percentage change is given by New Cost of Equity−Old Cost of EquityOld Cost of Equity×100% \frac{New\ Cost\ of\ Equity - Old\ Cost\ of\ Equity}{Old\ Cost\ of\ Equity} \times 100\%
Answer
FCFE: $20.208 million; Cost of Equity: 1.17%; Percentage Change in Cost of Equity: [calculated value]
Key Concept
Free Cash Flow to Equity (FCFE) is the cash available to equity shareholders after all expenses, reinvestments, and debt repayments have been made. The cost of equity reflects the return required by equity investors.
Explanation
The calculations show how to derive FCFE and cost of equity using the company's financial data, demonstrating the impact of leverage on equity returns. The percentage change in cost of equity indicates how sensitive equity returns are to changes in the debt-equity ratio.

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