Business Case

Analysis:
IPO Valuation of
Morgan Stanley Group,
Inc.
LETTER OF TRANSMITTAL
18 December, 2016
Professor Md. Sadiqul Islam
Department of Finance,
Faculty of business studies,
University of Dhaka
Subject: submission of term paper.
Dear Sir,
It is an immense pleasure for us to submit the project report on Case analysis of Morgan
Stanley IPO valuation (F-307: Investment analysis & Portfolio management) of BBA
program under Department of Finance, University of Dhaka.

This report gave us an occasion to apply our theoretical expertise, sharpen our views,
ideas, and analytical skills, and bridge them with the real world of practical experience,
which will be a good head start for our future professional career. The experience that we
gathered through this project report was very interesting, joyful and valuable one. This is
an ideal ground for us to put in our theoretical knowledge in the practical ground.

We would like to convey our special thanks and gratitude to you for patronizing our effort
& for giving us proper guidance and valuable advice. We have tried our best to cover all
the relevant fields. we are looking forward to receive your cordial approval of our
submission.

Yours sincerely\\

Name ID No. Signature

Samia Chowdhury Sifa 20_123
Joysree Paul Nishi 20_143
Muhammad Imdadul Islam 20_145
Md. Imran Hossain 20_149

pg. 1
EXECUTIVE SUMMARY

Morgan Stanley Group incorporated in August 1998, is one of the fastest growing airlines in
USA that follows a low cost- low fare strategy. This case study is describes the dilemma that
Morgan Stanley faced while valuing its shares during its IPO. In order to find solutions to the
dilemma, a three step valuation process was conducted.

The first step involved an economic analysis which clearly showed that the US economy after is
booming. The second step involved the industry analysis which revealed that Investment
Banking Industry according to the porters five forces analysis.

The third and final step of the valuation process involved a company analysis. This analysis
revealed that Morgan had a moderate level of business risk but a very high level of financial risk.

On the context of the above three steps, we calculated the intrinsic value of Morgan Stanleys
stocks using the FCFF model and the relative Ratio technique. Using the result of this techniques
as the basis, we suggested Morgan Stanley to price its shares between $75 and $ 85 during IPO.

Moreover, in addition to raising funds through public offering Morgan Stanley always can also
pursue some alternative courses of action. Namely, it can issue bonds or selling 25% of the firm
to a passive investor or becoming a minor player in the market. Both of these alternatives could
prove to be more cost efficient than a public offering.

All in All, Morgan Stanley Group should most certainly go public in order to increase the level
of equity in its overall capital structure, thereby reducing its exposure to financial risk. Moreover,
it should also invest heavily in developing its brand image as a long term strategy.

pg. 2
TABLE OF CONTENTS
Executive Summary.........................................................................................................................2
Introduction......................................................................................................................................4
Origin of the report......................................................................................................................4
Methodology................................................................................................................................4
Objectives.....................................................................................................................................5
Limitations...................................................................................................................................5
Chapter 1: Company Overview.......................................................................................................7
Chapter 2: Analysis of Economy...................................................................................................10
Chapter 3: Analysis of the industry...............................................................................................13
3.1 Porters Five Forces Analysis...............................................................................................13
3.2 PESTLE Analysis.................................................................................................................16
Chapter 4: Analysis of the Company.............................................................................................20
4.1 Risk Assesment....................................................................................................................20
4.2 Ratio Analysis......................................................................................................................21
4.3 Du Pont Analysis..................................................................................................................22
4.4 SWOT Analysis....................................................................................................................23
Chapter 5: Problem Statement.......................................................................................................26
Chapter 6: Alternative Courses of Actions....................................................................................28
6.1 Bond Issue............................................................................................................................28
6.2 Merge with large capitalized buyer......................................................................................28
6.3 Initial Public offering (IPO).................................................................................................28
Chapter 7: Evaluation of the alternatives.......................................................................................31
7.1 Evaluation of Bond..............................................................................................................31
7.2 Evaluation of Merger...........................................................................................................31
7.3 Evaluation of IPO.................................................................................................................31
Chapter 8: Recommendation.........................................................................................................35
Conclusion.....................................................................................................................................35
Appendix........................................................................................................................................36
Bibliography..................................................................................................................................38

pg. 3
INTRODUCTION

ORIGIN OF THE REPORT

In the way of attending the BBA Program in one of the finest university round the globe we are
to get acquainted with the best knowledge and techniques. In such case, regarding the Course (F-
307): Investment Analysis & Portfolio Management requirement, we were assigned to prepare a
report on IPO Valuation. This report was assigned to us by our honourable course teacher Prof.
MD. Sadiqul Islam, Professor, Department Of Finance, University Of Dhaka, to assess our
understanding of the Investment analysis and valuation of firm.

METHODOLOGY

The study requires a systematic procedure from the selection of the topic to final report
preparation. To perform the study data sources are to be selected and collected, they are to be
classified, interpreted and presented in a systematic manner and key points are to be found out.

Selection of the Study: This topic was assigned by our honourable course instructor and
the company was selected by all of our group members.

Identifying the Data Sources & Data Collection: Essential data sources were needed to be
identified and collected to prepare the report.

Classification, analysis, interpretation and presentation of Data: To classify, analyze,

interpret and presentation of we used some analytical and graphical tools to understand them
clearly.

Findings of the study & report preparation: After scrutinizing the data problems of the
study are pointed out and they are shown under concerned heads and the final report is prepared.

pg. 4
OBJECTIVES

It is important to define our perceived objectives behind preparing this paper to make this a
meaningful effort. The objectives of the study are given bellow:

Review the institutional aspects of the equity issuance transaction.

Explore the costs and benefits associated with public share offerings.

Develop an appreciation for the challenges of valuing unseasoned firms.

Hone corporate valuation skills, particularly using market multiples.

Evaluate the received explanations of various finance anomalies, such as the IPO under
pricing phenomenon.

LIMITATIONS

This report has the following limitations-

Use of forecasted data

Key variables of the valuation techniques applied in this report were assumed.

Discounting rates were estimated from given range and in some cases we had to assume
the key variables of discounting rate estimations.

Lack of market data.

pg. 5
 Chapter 1
Company Overview
pg. 6
CHAPTER 1: COMPANY OVERVIEW

Company Name: Morgan Stanley & Company

Incorporated: In 1935.

Employees: 3850 (in February 1986).

Total Assets: 15.79 Billion (31 December, 1985)

Core Businesses: Three core Businesses Investment Banking, Asset Management, Sales and
trading.

Services: Underwriting, Managing and Distributing corporate and governmental securities.

Branches: New York (Head Branch), Chicago, San Francisco, Los Angeles (By 1986).

COMPANY FOUNDING HISTORY

The disastrous business practices of banks during the decade before the stock market crash on
October 29, 1929 provided the real impetus for the birth of Morgan Stanley. During these years,
commercial banks speculated with their depositors moneyborrowed moneyand played the
market on margin. The Banking Act of 1933, better known as the Glass-Steagall Act, affected the
investment banking industry more significantly than any other piece of legislation by requiring
the separation of commercial and investment banks. J.P. Morgan and Company chose to pursue
deposit banking. Within a year and a half of this decision, three of its partners organized Morgan
Stanley & Co. Incorporated to enter the investment banking business. The new company was
incorporated on September 16, 1935 and claimed some of the most experienced men in
investment banking as assets.

Expansion Phases: Three Phases

pg. 7
FIRST PHASE (1973-1977):

Focused on building a distribution capability

Mastery of additional securities
Growth was in-
o Corporate bond sales (1971)
o Equity sales and trading (1973)
o A London operation and asset management (1975)
o Government bonds (1976)
o High-net-worth individuals (1977)

SECOND PHASE (1982-1985):

Emphasized trading and positioning activities

The expansion into related markets
o Money markets
o Commercial activities
o Commodities and Fixed Income research (1982)
o Tax-exempt bonds and commercial bonds (1983)
o Mortgage-backed and high-yield bonds (1984)

THIRD PHASE (1986 - ):

Enlarging and making permanent the firms capital

Allowing a fuller responses to perceived high-return trading opportunities
Broadening funding source (including commercial papers).

pg. 8
 Chapter 2
Analysis of Economy
pg. 9
CHAPTER 2: ANALYSIS OF ECONOMY

Macroeconomics is the study of the behavior of the economy as a whole. This is different
from microeconomics, which concentrates more on individuals and how they make economic
decisions. Needless to say, macro economy is very complicated and there are many factors that
influence it. These factors are analyzed with various economic indicators that tell us about the
overall health of the economy. Macroeconomists try to forecast economic conditions to help
consumers, firms and governments make better decisions.

Morgan Stanley & Company faced

Booming Economy: In 1983, the U.S. government 90-day Treasury bonds interest rate was
8.63% and in 1985(Dec), this rate lowered at 7.07%. Also, the interest rate on AAA rated bonds
was 12.04% and in 1985(Dec), the rate lowered at 10.16%. On the other hand, the indexes on
common stocks were flourishing as S&P 500 index was $160.41 in 1983 and $207.26 in
1985(Dec). The NYSE finance index in 1983 was $95.34 and $128.86.

So, the economic situation is in favor of investors and so much active investment banks.

More capital accelerated economy: Rapid growth of economy led the existing firms to
accumulate more and more capital for outperforming the economy and get rid of the competitors.
For huge capital needs, there was an introduction of new trends, like - selling a portion of
controlling interest of firms to another cash-rich firm. Thus change in ownership and decision
making structure allows the portion-selling firm to manage future capital needs.

This attractive economy approaches the firms to reach the opened window, in which to take a
firm public.

pg. 10
Approaching to go Global: One of the strategic thrust of economys existing firm to seek the
interest of overseas client. This was for -

Global recognition and domination

Access to global fund through international stock exchanges
Building international relationship

pg. 11
 Chapter 3
Analysis of Industry

pg. 12
CHAPTER 3: ANALYSIS OF THE INDUSTRY

Industry analysis is a tool that facilitates a company's understanding of its position relative to
other companies that produce similar products or services. Understanding the forces at work in
the overall industry is an important component of effective strategic planning. Industry analysis
enables small business owners to identify the threats and opportunities facing their businesses,
and to focus their resources on developing unique capabilities that could lead to a competitive
advantage. We will now introduce two renowned industry analysis tools for Morgan Stanley &
Company.

3.1 PORTERS FIVE FORCES ANALYSIS

Threat of New Entrants

In general, industries are more attractive when the threat of new entrant is low. This means that
competitors cannot easily enter the industry to copy what the incumbents are doing .In this
investment banking industry, there is already lot of competitors exist who have greater financial
resources, huge opportunity to manage & accumulate capital fund needs. Morgan Stanley &
Company, in investment banking industry, needs to compete with these competitors. So, the
threat of new entrant is very low. Because new venture may not have available resources, huge
opportunity to manage & accumulate capital fund needs & other competitive strategy to compete
with this already established industry.

Threat of Substitute services

Normally, Industries are more attractive when threat of substitutes is low. This means services
from other industries cant easily serve as substitutes for the services being performed &
commissions, interest and dividends earned in the focal firms industry. The industry where
Morgan Stanley & Company belongs - emphasized on corporate bond sales, Equity sales and

pg. 13
trading, asset management, Government bonds High-net-worth individuals Threat of substitute
product is very high. From this point of view, the industry is not more attractive.

Rivalry among existing firms

In most industries, the major determinant of industry profitability is the level of competition
among the firms already exist .Some industries are fiercely competitive to the point where prices
are pushed below the level of costs .When this happens, industry wide losses occur. In this case,
we found that there is more competition among the firms of the investment bank industry.
Morgan Stanley & Company competed with local & national investment banks and other
international investment banks, Asset Management, Sales and trading and most of which had
extended level of investment capital & expanded service lines in response to competition
provided by top rated investment firms.

Bargaining power of suppliers

The presence of powerful suppliers of capital fund reduces the profit potential in an investment
banking industry. Suppliers increase competition within an industry by threatening to raise prices
or reduce the quality of goods and services. Morgan Stanley & Company interested to issue new
stock. So, new issue would strengthen the bargaining power with its lenders.

Bargaining power of buyer

Normally, industries are more attractive when the bargaining power of buyers will be low.
Buyers can suppress the profitability of the industries from which they purchase by demanding
price concessions or increase in quality. Our relevant industry is investment banking industry.
Due to low service differentiation between competitors & lot of available option of investment
for individual investors and other investment institution, would increase the bargaining power of
the investors and it is high here.

pg. 14
 Porters five forces comparative model for Morgan Stanley
Forces Level of Intensity and Competition
Marking
Lo Mediu Hig
w m h
(2)
( (
1 3
) )
Threat of new entrants
1. Huge Capital requirement
2. Higher opportunities on first
mover in industry

Rivalry among existing firms

1. High Number of Competitors
2. High level of competition
Threat of substitutes
1. Booming Economy
2. Lower switching cost
Bargaining power of the buyer
1. Low Degree of Service
Differentiation
2. High level of Available
switching option
Bargaining power of the supplier
1. Number investment capital
Suppliers
2. High Threat of Increase in
required return rate
Markings 1 - 12

So, total competition mark is 12+1 = 13, which indicates average competition mark (13/3) is
4.33. This mark is higher than the level of high competition mark (3). So, Morgan Stanley would
face an upper level of high competitive forces in the particular industry.

pg. 15
3.2 PESTLE ANALYSIS

Originally known as PEST Analysis, this is a macro environmental framework used to

understand the impact of the external factors on the organization and is used as strategic
analytical technique. PEST stands for "Political, Economic, Social, and Technological factors.

Later Legal and Environmental factors were also added by some analysts and thus evolved the
term PESTLE Analysis.

Political Factors

Factors effecting the organizations in terms of government regulations and legal issues are
defined both formal and informal rules under which the firm must operate. Political stability is
very important for the economic growth of a company. From the analysis of historical economic
information we can predict the political environment. Because we know that there is a positive
relationship between economic efficiency and political stability. Regulatory factors like tax
policy, environmental regulation or other legal issues are important. Regulation for Morgan
Stanley in Tokyo Stock Exchange as like, the exchange wouldnt allow U.S. firms to double
leverage their capital base in the United States. So, this regulation required Morgan Stanley to
dedicate new capital to these new markets.

Economic Factors

Economic factors act as a driving force for any industry. Stage of business cycle, current &
projected economic growth, e.g. GDP / GNP growth, inflation & interest rates, unemployment,
impact of globalization, levels of disposable income & income distribution, likely changes in the
economic environment. Because of globalization, Morgan Stanley had significant penetration in
corporate finance in the United Kingdom. It was also the leader in the trading of American

pg. 16
Depository Receipts. Morgan Stanley was one of only three American firms allowed to trade on
the Tokyo Stock Exchange.

Social Factors

Morgan Stanley would create greater customer value by ensuring full-service investment bank
than any other companies. Social factors also have great impact on an industry. Like- population
health, education & social mobility, population employment patterns, job market freedom &
attitudes to work, press attitudes, public, social attitudes & social taboos lifestyle choices and
attitudes to these, socio-cultural changes health consciousness.

Technological Factors

Technological factor is very important for the industry too. The rate of technology change is an
important factor here. Some technological factors are-impact of emerging technologies, impact
of internet, reduction in communication costs & increased remote working, research &
development (R&D) activity, impact of technology transfer, degree of automation, rate of
technological change. These factors have an impact on the industry where Morgan Stanley

pg. 17
planned to penetrate which can expand their business well like introducing new technologies into
its organization.

Environmental Factors

Factors refer to ecological and environmental aspects such as weather, climate, and climate
change. Morgan Stanley was affected by underwriting, a debt securities offering for Oxoxo Inc.,
a petroleum company, because of unexpected oil refining loss. Govt. and other parties are now
cautious about environmental pollution and its solution.

Legal Factors

Factors influence the companys operation, its costs, and the demand for its products. Factors
include: Consumer law, Anti-trust law, Food -safety laws, employment laws etc..Various
regulations required Morgan Stanley to maintain at least minimum level of net capital relative to
Aggregate Debit Items.

pg. 18
 Chapter 4
Analysis of the Company

pg. 19
CHAPTER 4: ANALYSIS OF THE COMPANY

4.1 RISK ASSESMENT

Risk analysis

Analysis of fundamental sources of uncertainty can be called analysis of risk. Fundamental sources of
risk are:

Business risk: Business risk is the uncertainty of income flows caused by the nature of a firms
business. Here the income sources of Morgan Stanley are commission, asset management, interest
and dividends etc.

Financial risk: Financial risk is the uncertainty by the method by which the firm finances its
investment. Morgan Stanley finances its investment by debt financing.

Liquidity risk: Liquidity risk of Morgan Stanley is associated with that for a certain period of time
at a given financial asset, security or commodity cannot be traded quickly enough in the market
without impacting the market price.

Exchange rate risk: Exchange rate risk is the uncertainty of returns to an investor who acquires
securities denominated in a currency different from his or her own. Morgan Stanley had achieved
significant penetration in corporate finance in United Kingdom, Scandinavia and Japan with some
business in France and Italy as well. So, there is a huge chance of exchange rate risk.

Political risk: It is also called country risk. Political risk is associated with the change of political
or economical situation. Morgan Stanley

4.2 RATIO ANALYSIS

pg. 20
Liquidity ratios Numerator denominator value
Current ratio Current asset Current liability 1.3214

The company has current asset amount 4,877,658 and current liabilities 3636574. The liquidity
of the company is high because it has more than enough amount of assets to repay liabilities
instantly.

Efficiency ratios Numerator Denominator value

Accounts receivable turnover Credit sale Acc receivable 0.8132474

Equity turnover Revenue Average 11.433189

stockholders
equity
Fixed asset turnover Revenue Fixed asset 0.1644218
Total asset turnover Revenue Total asset 0.1136438

Efficiency measures for the criteria to analyze how well the company can manage its assets and
liabilities internally. We see company manage its account receivable tightly. Company efficiently
manage its equity to generate revenue than total asset.

Profitability ratios Numerator denominator value

Net profit margin Net income Revenue 5%
Return on asset Net income Total asset .6%
Operating profit margin Net income Revenue 10%
Return on ROE Net income Fixed asset 33%

The company has a net profit margin of 5% but operating profit margin of 10% . The company
has to pay big amount of tax annually. A large portion of company return come from
shareholders equity than companys total asset.

4.3 DU PONT ANALYSIS

The importance of ROE as an indicator of performance makes it desirable to divide the ratio into
several component ratios that provide insights into the cause of a firms ROE or any changes in it
(Brown and Reilly, 2009). This breakdown is generally referred to as the DuPont System.

ROE=Net income/Common equity= Profit margin Total asset turnover Financial leverage

pg. 21
 ROE

Profit margin=Net Financial leverage=Total

income/net sales asset/common stock

Total asset turnover=Net

Net income=Total Net sales sales/Total assets
revenue-total
expense-tax
payment Total Common stock
asset=Current
asset+ fixed asset
Net sales= Sales- Total asset
discount

DuPont analysis of Morgan Stanley:

ROE=Net income/net sales Net sales/Total asset Total asset/ common stock

Profit margin 0.058973

Total asset turnover 0.113644
Financial leverage 801.6499
ROE 5.372551

pg. 22
 Profit Margin = 0.059

Total Asset Turnover = 0.113644

Financial Leverage = 801.6499

ROE of Morgan Stanley

4.4 SWOT ANALYSIS

Through the SWOT analysis method, company officials can make a strategic plan for a particular
project or process (Cadle et al., 2014). SWOT is composed of two factors. One is internal factors
another is external factors. Strength and Weakness are internal to the firm. On the other hand,
Opportunities and Threats are external to the firm.

Strength: Strength of the firm gives the company comparative advantage over market place. It
includes high quality product, strong brand images, customer loyalty etc. Morgan Stanly
strengthen its position in the market place through

Strong brand image,

market leadership and

Strong customer relationship.

Weakness: Market share of Morgan Stanley is decreasing day by day, it is one of the main
weaknesses of this company that lead insufficiency in resources. Low capital is another
weakness.

pg. 23
Opportunity: Opportunities include environmental factors that favour the firm.

1. Positioning itself as a full service investment bank.

2. Large market share gain in municipal finance

3. To introduce new information technologies into its organization.

4. Regain its dominance in underwriting business.

Threat: Threats are the environmental factors that hinder the activities of the firm. Some of
Morgan Stanleys threats are:

Increasing competition in the marketplace.

Increasing market share of the competitors.

There is a legal binding if net capital fall from 2% of aggregate debit items, the firm
could be suspended from trading , expelled from exchange.

pg. 24
 Chapter 5
Problem Statement

pg. 25
CHAPTER 5: PROBLEM STATEMENT

5.1 The symptoms

Decreasing market share in Underwriting Business: In 1982, the market share was 11.6%
for Morgan Stanley and in declines to 5.6% in 1985.
Weak position in Municipal Finance: Morgan Stanleys market share was very small
because of its late entry.
Small Risk Taking Approach in Retail effort: Morgan Stanleys conservative in risk
taking for small retail effort due to increase in Commission.
Restriction on U.S firms not to double leverage the capital base

5.2 Key issues

Competitors are growing with huge capital base.
Limited capital in Municipal finance sector.
Forgoing opportunities due weak capital base of Morgan Stanley.
Globalization requires capital on site on the business countries.

5.3 Core Problem

Developing a financial plan for business expansion: The financial plan which will
manage-
- New capital
- Improvement of Financial Flexibility

The questions that arise from the problem are:

Q.1 Why Morgan Stanley needs external money?

Q.2 How Morgan Stanley will manage extra capital?

Q.3 Does the offering price range ($ 42 to $ 46) seem appropriate when it will opt for IPO?

pg. 26
 Chapter 6
Alternative course of actions

pg. 27
CHAPTER 6: ALTERNATIVE COURSES OF ACTIONS

According to its prospectus, Morgan Stanley is going public to raise funds to finance their
working capital and capital expenditure needs, especially to finance the expansion of
underwriting and municipal finance business.

However, In addition to going public, there are some other ways through which Morgan Stanley
can support its rapid growth.

6.1 BOND ISSUE

Instead of raising the entire amount by issuing common stock, Morgan Stanley can raise a
sizeable portion of it through issuing bond and debentures.

According to Exhibit 3, the YTM of a 30 year U.S. treasury bond is 7.96% at March, 1986. If we
assume this figure to represent the general return that the bond purchasers seek in the market and
compare it with the return those equity investors of Morgan Stanley, as represented by their cost
of equity of 16%, we can conclude that Bond issue might be a more cost effective source of
financing for Morgan Stanley than issuing equity.

6.2 MERGE WITH LARGE CAPITALIZED BUYER

The company can merge with large institution to meet its capitals needs. It can merge fully or
within some percentage to make the expansion in its business.

Morgan Stanley would be able to maintain its expansion strategy with this. But there can be
problem of environmental diversity.

6.3 INITIAL PUBLIC OFFERING (IPO)

IPO is another option for Morgan Stanley to manage its required capital. And Morgan Stanley
opts for this option. Because, it will eliminate most of the drawbacks for managing the capital.

For stepping in IPO, Morgan Stanley would need to make the valuation of its stock price.

pg. 28
Valuation is the process of determining the current worth of an asset or company. There are many
techniques that can be used to determine value, some are subjective and others are objective.

pg. 29
 Chapter 7
Evaluation of Alternatives

pg. 30
CHAPTER 7: EVALUATION OF THE ALTERNATIVES

7.1 EVALUATION OF BOND

Advantages Disadvantages

Less floatation costs involved
More cost effective financing than issuing
shares
Less complicated process of issuance
Bond indentures might restrict the activity of
the firm
May not raise as much funds as IPO
Increases the financial risk of the firm

Allows diversification of the overall capital

structure

7.2 EVALUATION OF MERGER

Advantages Disadvantages

Reduced Cost High Financial Risk

Reduce Competition Diverse environment

Easy expansion Complexity in issuance

7.3 EVALUATION OF IPO

Stock valuation of Morgan Stanley can be done in various financial approaches like-

Dividend Discount Model

Free cash-flow to equity method (FCFE)
Free Cash-flow to Firm method (FCFF)
Market Multiples

pg. 31
However, in this case we cannot use DDM approach because Morgan Stanley is deciding to go
public by selling IPO shares and has not declared any dividend. We have used FCFF and FCFE
methods in valuation process. We made our assumption based on the financial forecast of JetBlue
management.

7.3.1 Assessing the Advantage:

Advantages Disadvantages

Reduced Cost High Financial Risk

Reduce Competition Diverse environment

Easy expansion Complexity in issuance

7.3.2 Key Assumptions for Valuation

Revenue Assumptions

Investment Banking
Principal Transactions
Other Revenue Sources
46.6% increase in the first three years and it will continue to
grow at 7%.
27.4% increase in the first three years and it will continue to
grow at 7%.
28.8% increase in first 3 years. Then it will continue to grow at
6% per year.

Expense Assumptions

Other Expenses 14% - First 5 years

12% - Rest of the years
Compensation and Benefit It will reduce first 5 years by 1 percent. Then will increase at a
rate of 3%

Depreciation Depreciation is 75% of the other cost.

pg. 32
Interest expense
Tax expense
Balance Sheet Item Assumptions
Current Asset
Current Liability
Fixed Asset
Financing Assumptions
New Borrowing
Repayment of Loan
Other Factors Assumptions
Cost of equity
Sustainable Growth rate
As the firm is going public they will have an abundant access to
equity funding so they will require lesser and lesser debt capital
as well as loan from banks. We assume there will be
3% - 1st five years
6% - Remaining years
Historically the tax rate of the company ranged from 42% to
47% so we assume the future tax rate will be (46.5%+ 45.12%
+40.6%+ 42.8%+ 42.3%)= 43.37% and for simplicity we
assume that there is no deferred tax asset and liability.
First four years , 7%
Remaining years, 6%
First four years , 8%
Remaining years, 6%
First three years , 18%
Remaining years, 6%
9% of long debt
First five years , 7%
Remaining years, 3%
Cost of equity has been calculated by CAPM model.
Risk free rate 7.96% is the 30 year US government treasury
bond rate. Average maret return is 14%.
As the company is relatively new in public market and have a
heavy debt proportion in its capital structure, it will have a
above average risk than the market i.e. >1. We assume that
=1.4
So the cost of equity = 7.96 + 1.4(14%-7.96) =16%.
ROE is 40%
D/E is 80%
pg. 33
 Retention Rate is 20%
Sustainable Growth rate is 6%

7.3.3. Intrinsic Value of Common Stock of Morgan Stanley

Free cash flow to equity Free cash flow to equity measures $77.82
the capacity of the company to pay
dividend.
Free cash flow to firm Free cash flow to firm measures the $85.49
capacity on its debt and equity

Chapter 8
Recommendation
pg. 34
CHAPTER 8: RECOMMENDATION

In light of the findings of this report, we have the following recommendations for JetBlue
Airways:

1. Morgan Stanely should go Public immediately in order to increase the portion of equity
in their overall capital structure. The Price should of stock should be between $75 and $86. This
is necessary to reduce their exposure to financial risks, which currently is very high as
represented through their leverage ratios

2. Morgan Stanely should sell their common stocks at a premium during the IPO. This will
allow them to raise large amount of capital by taking advantage of the high investor demand..

3. Morgan Stanley should invest heavily on building their Brand Value in an attempt to
overthrow its competitors.

CONCLUSION

In our opinion, the investment bank is in a comfort zone because as the shares are undervalued,
they have potential growth opportunities. Even if they cannot sell all the shares, holding the
shares can be profitable for investment bank. Because these shares are expected to generate
above average return in future.

pg. 35
APPENDIX

Appendix-1

pg. 36
Appendix-2

BIBLIOGRAPHY

pg. 37
Cadle, J., Eva, M., Hindle, K., Paul, D., Rollason, C., Turner, P., Yeates, D. and Cadle, J. (2014).
Business Analysis. 1st ed. Swindon: BCS Learning & Development Limited.

Brown, K. and Reilly, F. (2009). Analysis of investments and management of portfolios. 1st ed.
[Mason, OH?]: South-Western.

Jeffs, C. (2008). Strategic management. 1st ed. Los Angeles: SAGE.

pg. 38