Net Present Value and Free Cash Flow
1. Given the proposed financing plan, describe your approach (qualitatively) to value AirThread. Should Ms. Zhang use WACC, APV or some combination thereof? Explain. (2 points) * From the statement of AirThread case, we know that American Cable Communication want to raise capital by Leveraged Buyout (LBO) approach. This means ACC will finance money though equity and debt to buy AirThread and pay the debt by the cash flows or assets of AirThread. * In another word, it’s a highly levered transaction using a fixed WACC discount rate; however the leverage is changing in fact. * If we want to use WACC method, one assumption must be met: this program will not change the debt-equity ratio of AirThread. Under LBO approach, it’s impossible. * So we decide to use APV method to value AirThread. WACC method is not appropriate here, but we still need to calculate the weight average cost of capital (WACC) of AirThread.
Approach to value AirThread before considering any synergy
1. Develop a projection of unlevered free cash flow for AirThread. * Discount AirThread’s unlevered free cash flows at unlevered WACC.
2. Determine the PV of interest tax shield: * Discount AirThread’s interest tax shield by debt cost of capital (interest rate of debt).
3. Add the unlevered value to the PV of interest tax shield to get the value of the acquisition.
4. Using Dividend Discount Model (Gordon Growth Model) to estimate the terminal value.
5. Estimate the value of operating assets based on the above (without synergies).
6. Add the value of non-operating assets (excess cash, securities, investments) to get a total value of AirThread.
7. Minus the debt value from the total value of ATC to get an equity value of AirThread.
2. What discount rate should Ms. Zhang use for 2008 through 2012? Should she use the same discount rate to value the terminal value? Why or why not? (2 points)
Chart 1
In order to calculate the discount rate: * We need to get the. We
Approach to value AirThread before considering any synergy
1. Develop a projection of unlevered free cash flow for AirThread. * Discount AirThread’s unlevered free cash flows at unlevered WACC.
2. Determine the PV of interest tax shield: * Discount AirThread’s interest tax shield by debt cost of capital (interest rate of debt).
3. Add the unlevered value to the PV of interest tax shield to get the value of the acquisition.
4. Using Dividend Discount Model (Gordon Growth Model) to estimate the terminal value.
5. Estimate the value of operating assets based on the above (without synergies).
6. Add the value of non-operating assets (excess cash, securities, investments) to get a total value of AirThread.
7. Minus the debt value from the total value of ATC to get an equity value of AirThread.
2. What discount rate should Ms. Zhang use for 2008 through 2012? Should she use the same discount rate to value the terminal value? Why or why not? (2 points)
Chart 1
In order to calculate the discount rate: * We need to get the. We