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Course Name:

CORPORATE FINANCE CASE 3 Valuation of AirThread Connections


GROUP G15

Assignment Title: Submitted by:

Group Member Name Aditi Mittal Jyotsna Mahara Sahil Dhar Hakim Sumit Pokhriyal Vishal Lahoti SOLUTION Assumptions taken for calculations :

PG ID 61310666 61310500 61310491 61310475 61310231

(Let us not waste paper, please continue writing your assignment from below)

1) While calculating unlevered for comparables, we assumed the debt to be a post-tax value. 2) Comparable companies revenues are lower than AirThread so it seems better to take the average of all the companies Beta. 3) D/E ratio is changing year to year so it is better to evaluate the firm using APV. We have used below mentioned figures while calculating unlevered cost of equity i. Marginal Tax Rate ii. Debt Beta iii. Market Risk Premium iv. Risk Free Rate v. Cost of debt 40% 0.00(assuming debt at market risk free) 5.00% 4.25% 5.5% 1 Study-Group G15

4) for the calculation of terminal value, we can take the long term growth rate of free cash flows at 3% which is a growth rate of a developed economy. 5) Cash flows can be calculated by EBIT(1-Tax%) + Depreciation Net Working capital. Since, we are using APV so this FCF needs to be discounted using unlevered equity cost of capital. For discounting terminal value, we are using WACC assuming that after 5 years, AirThread leverage ratio will be constant and in line with those of industry. 6) We are counting PV of equity affiliates by multiplying it with industry average P/E.

Equity Comparable Companies: Market Value

Net Debt

Debt/ Value

Debt/ Equity

Equity Beta

Revenue

EBIT

EBITDA

Net Income

(Asset)
Unlevered

Weightage

Weighted Beta

Universal Mobile Neuberger Wireless Agile Connections Big Country Communications Rocky Mountain Wireless Average

65,173 94,735 37,942 47,314 5,299 50,093

60,160 27,757 9,144 15,003 2,353 22,883

48.0% 29.3% 19.4% 24.1% 30.7% 30.3%

92.3% 41.4% 24.1% 31.7% 44.4% 46.8%

0.86 43,822 0.89 42,684 1.17 34,698 0.97 38,896 1.13 4,064 1.00 164,164

11,795 7,020 1,631 6,702 510 5,532

16,949 3,794 14,099 4,103 9,914 (30) 12,614 3,384 1,028 240

0.45 0.63 0.94 0.74 0.78

1.00 1.00 1.00 1.00 1.00 5.00 Unlevered Beta Average P/E

0.45 0.63 0.94 0.74 0.78 3.54 0.71 13.19

Debt/ Value 0.00%

Debt/ Equity 9.00%

Asset Beta 0.76

Equity Cost of Cost of Beta Equity Debt Unlevered Cost of Capital 0.70 7.74% 5.50% 7.37%

Unlevered Cost of Capital = 7.37% Since D/E ratio is changing every year, APV is a better method for doing the valuation of the company. By using Exhibit 1 given in the case, the net capital workflows of AirThread without synergy for the given projection years are calculated as shown below :
Working Capital Assumptions Accounts Receivable Days sales equip rev. prepaid expenses Accounts Payable Deferred Serv. Revenue Accrued Liabilities Net Working Capital Increase in NWC 2007 435.5 101.0 41.6 260.8 143.4 59.2 114.6 0 2008 521.93 134.97 46.89 335.45 132.24 64.66 171.4 56.8 2009 595.00 153.86 53.46 382.42 150.75 73.71 195.4 24.0 2010 669.37 173.10 60.14 430.22 169.59 82.92 219.9 24.4 2011 736.31 190.41 66.15 473.24 186.55 91.21 241.9 22.0 2012 787.85 203.73 70.78 506.37 199.61 97.60 258.8 16.9

We also need to reduce the effect of the interest payment, i.e the tax shield from the FCF in order to get the unlevered FCF of AirThread. Below is the table for the interest payment calculation arrived from Debt Repayment Schedule given in the case.

2 Study-Group G15

2008 2009 2010 2011 Interest Expense per Annum ($mn) 199.43 183.08 165.80 147.55 Principal payment per Annum 289.92 306.28 323.55 341.80 After-Tax Interest Expense per Annum 119.66 109.85 99.48 88.53

2012 128.27 2,495.99 76.96

Tax Shield PV of Tax Shield

2008 79.77 75.61

2009 73.23 65.79

2010 66.32 56.48

2011 59.02 47.64

2012 51.31 39.26

Total PV of Tax Shield is $ 284.78 FCF and Cash estimation of AirThread without counting the synergy is given below. Note that at end of 2012, company is short of cash. This is because of reduction in margin and increase in operating cost because of stiff competition in industry

2008 Operating Results: Service Revenue Plus: Equipment Sales Plus: Synergy Related Business Revenue Total Revenue Less: System Operating Expenses Plus: Backhaul Synergy Savings Less: Cost of Equipment Sold Less: Selling, General & Administrative EBITDA Less: Depreciation & Amortization EBIT Tax Rate Earnings After taxes Un-Levered Free Cash Flow Present Value of FCF 4,194.33 314.77 0.00 4,509.10 838.87 0.00 755.46 1,803.64 1,111.14 705.23 405.91 40% 243.55 260.65 242.76

2009 4,781.54 358.84 0.00 5,140.38 956.31 0.00 861.22 2,056.15 1,266.70 803.96 462.74 40% 277.64 337.90 293.11

2010 5,379.23 403.70 0.00 5,782.93 1,075.85 0.00 968.87 2,313.17 1,425.04 867.44 557.60 40% 334.56 310.17 250.58

2011 5,917.15 444.07 0.00 6,361.22 1,183.43 0.00 1,065.76 2,544.49 1,567.54 922.38 645.16 40% 387.10 317.39 238.81

2012 6,331.35 475.15 0.00 6,806.50 1,266.27 0.00 1,140.36 2,722.60 1,677.27 952.91 724.36 40% 434.62 315.60 221.17

Excess Cash: Less: After-Tax Interest Expenses Less: Scheduled Principal Payments Excess Cash

2008 (119.7) (289.9) (148.9)

2009 (109.8) (306.3) (78.2)

2010 (99.5) (323.6) (112.9)

2011 (88.5) (341.8) (112.9)

2012 (77.0) (2,496.0) (2,257.4)

Cash on Balance Sheet

55.57

(22.6)

(135.5)

(248.5)

(2,505.8)

3 Study-Group G15

APV value of AirThread should be the summation of PV(FCF) + PV(Interest Shield) + PV(Non Operating asset) + PV(Terminal Value)

NPV Calculation Present Value of FCF Interest Tax Shields PV of Interest Tax Shields Terminal Value Growth rate TV at end of 2012 PV of Terminal Value Equity in earnings of Affiliates Value of affliates NPV of the Airthread

2008 2009 2010 2011 2012 242.76 293.11 250.58 238.81 221.17 79.8 73.2 66.3 59.0 51.3 75.6 65.8 56.5 47.6 39.3 3% Taking long term economy growth rate 7438.62 5212.89 90 from exhibit 4 1187.33 7,931.43

NPV of Airthread without synergy is $7931.43mm Without the synergy, AirThread valuation seems cheaper but free cash flow of the company is decreasing year on year which suggests that AirThread needs ACC in order to benefit from reduction in operating costs and increase in market share. In order to find the benefit of two companies merger, we need to analyse the net benefit of the synergies between two companies.

Valuation With synergy taking into account Revenue and cost benefits can be calculated from Table 4 and 5 of the case.
Wireless Business Subscribers: Average Monthly Subscribers (in MM's) Average Monthly Minutes Total Monthly Minutes Revenue Per Minute Annual Business Revenue Increase Backhaul Savings: System Operating Expenses Backhaul Percentage Estimated Backhaul Costs Reduction in Backhaul Costs Backhaul Savings 2008 0.30 859 258 0.0506 156.5 2009 0.50 885 442 0.0506 268.6 2010 0.70 911 638 0.0506 387.3 2011 1.00 939 939 0.0506 569.9 2012 1.20 967 1,160 0.0506 704.5

838.9 20.0% 167.8 0.0% 0.0

From Table 4 956.3 1,075.8 20.0% 20.0% 191.3 215.2 7.0% 12.0% 13.4 25.8

1,183.4 20.0% 236.7 22.2% 52.5

1,266.3 20.0% 253.3 30.0% 76.0

4 Study-Group G15

In terms of synergy, the above savings and increase in revenue will modify working capital by changing account receivable, inventory etc. The revised calculation is given below:-

Working Capital Assumptions Accounts Receivable Days sales equip rev. prepaid expenses Accounts Payable Deferred Serv. Revenue Accrued Liabilities Net Working Capital Increase in NWC

2007 435.5 101.0 41.6 260.8 143.4 59.2 114.6 0

2008 540.04 134.97 47.76 341.63 134.67 65.85 180.6 66.0

2009 626.09 153.86 54.75 391.70 154.41 75.50 213.1 32.5

2010 714.21 173.10 61.92 442.97 174.62 85.38 246.3 33.2

2011 802.28 190.41 68.57 490.56 193.38 94.55 282.8 36.5

2012 869.39 203.73 73.62 526.69 207.62 101.51 310.9 28.2

The APV of the AirThread with synergy is given below. Due to increase in revenues and decrease in operating cost, there is a significant increase of worth of Airthread as shown below:-

NPV Calculation Present Value of FCF Interest Tax Shields PV of Interest Tax Shields Terminal Value Growth rate TV at end of 2012 PV of Terminal Value Equity in earnings of Affiliates Value of equity affliates NPV of the Airthread

2008 2009 2010 2011 2012 295.80 391.17 387.47 430.87 450.61 79.77 73.23 66.32 59.02 51.31 75.61 65.79 56.48 47.64 39.26 3% Taking long term economy growth rate 15155.7 10620.93 90 from exhibit 4 1187.331 14048.97

NPV of Airthread with synergy is $14048.97mm Conclusion We can see that NPV of Airthread with synergy is much higher than without synergy which leads to the conclusion that if both companies tie-up then there is a huge potential of upright revenue and hence increase in market capitalization. Please refer the Table 1 for cash estimation taking synergy into account.

5 Study-Group G15

Taking the above synergy in account, the estimated FCF and Cash in Balance sheet is as below:Table1
2008 Operating Results: Service Revenue Plus: Equipment Sales Plus: Synergy Related Business Revenue Total Revenue Less: System Operating Expenses Plus: Backhaul Synergy Savings Less: Cost of Equipment Sold Less: Selling, General & Administrative EBITDA Less: Depreciation & Amortization EBIT Less: Interest Expense Earning before taxes Tax Rate Net Income Un-Levered Free Cash Flow Present Value of FCF 275.9 40% 165.54 317.6 295.80 412.2 40% 247.33 451.0 391.17 591.9 40% 355.16 479.6 387.47 809.5 40% 485.69 572.6 430.87 996.1 40% 597.67 643.0 450.61 2009 2010 2011 2012

4,194.33 4,781.54 5,379.23 5,917.15 6,331.35 314.77 358.84 403.70 444.07 475.15 156.48 268.62 387.34 569.95 704.46 4,665.58 5,408.99 6,170.27 6,931.17 7,510.96 838.87 956.31 1,075.85 1,183.43 1,266.27 0.00 $ (13.39) $ (25.82) $ (52.54) $ (75.98) 755.46 861.22 968.87 1,065.76 1,140.36 1,866.23 2,163.60 2,468.11 2,772.47 3,004.38 1,205.03 1,441.26 1,683.26 1,962.06 2,175.92 729.70 845.97 925.54 1,005.02 1,051.53 475.32 595.28 757.72 957.04 1,124.39 199.4 183.1 165.8 147.5 128.3

Excess Cash: Less: After-Tax Interest Expenses Less: Scheduled Principal Payments Excess Cash

2008 (119.7) (289.9) (92.0)

2009 (109.8) (306.3) 34.8

2010 (99.5) (323.6) 56.6

2011 (88.5) (341.8) 142.3

2012 (77.0) (2,496.0) (1,929.9)

Cash on Balance Sheet

112.52

34.84

56.58

142.30

(1,929.95)

6 Study-Group G15

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