VALUTAION OF AIRTHREAD CONNECTIONS

14 Pages   |   3,048 Words
EXECUTIVE SUMMARY
ACC was one of the largest operates in te United States. It is considering an acquisition of the Airthread connections. The company would have many strategic advantages in doing so. But before going through the process, the financial viability of the process must be checked.
The analyst needs to calculate several financial figures in order to assess the financial condition. This report is a way through which the analyst can actually make final decisions. This report calculates and explains the weighted average cost of equity, the cost of debt, the cost of unlevered equity, the value of the non-operating assets, the terminal values of the cash flows, the free cash flows and many other key financial figures which would serve the analyst in making key financial decisions regarding the project.
The report recommends that the merger would add to the existing synergy. This claim can be verified by having a glance at the APV value, the NPV value and the other key financial figures.
 
THE STATEMENTS OF PROBLEM
The most important issues in this case areas follows:
  • The report would focus on the estimation of an optimal discount rate and free cash flows for the company.
  • It would estimate the adjusted and the net present values of the entire project.
  • It would decide whether the project should be considered or not.

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ANALYSIS
In order to estimate the financial value of the Airthread connections, the following steps have been followed in the calculations:
  • An appropriate discount rate has been calculated for the equity of the company. This discount rate has then been used to calculate the present value of the future cash flows of the company.
  • An appropriate discount rate has been calculated for the debt financing of the company.
  • Free cash flows have been estimated for the company. These have been estimated for the horizon time of the project.
  • The discounted value of the cash flows has also been calculated. This value adjusts the nominal value of cash flows against the time value of money and the upwards sloping yield curve.
  • The net present value of the free cash flows has been calculated using the equity discount rate.
  • Net value of the non-operatingassets has been calculated. This would also be followed by the discounted value of the non-operating assets. This value would then be added to the APV and the terminal cash flow values in order to get a final holistic value of the investment.
  • Net present value based upon the cost of the equity has been estimated.
  • Net present value based upon the cost of the entire financing has been estimated.
  • The payback period has been estimated for the project.
  • The discounted payback period has been estimated for the project.
An analysis of the Expected Stream of Revenues:
Exhibit 1 shows the expected revenues and cost which the company would incur in case of the acquisition. All the figures have been projected based upon the historical data. The revenues projected show. These figures have been estimated for a period of 5 years from 2007 to 2012.
It can be seen that the revenues are expected to grow at a rate of 9% overall. It is quite interesting to note that the overall growth in every cost and revenue has been assumed to be 9%. This means that not only the revenues but also the cost have been assumed to grow at 9%
The capital expenditures have been assumed to grow by 11% over the time period. However, the working capital; has been assumed to remain same throughout the time period and therefore no growth can be seen.
The Cost of Debt:
 The cost of debt has been prescribed as 5.5% in the amortization schedule. There is no addition of any default spread or sovereign spread as the project is within the United States. It can be seen that the weighted average cost of debt has risen over the time period. This is primarily because the company has relied a lot upon debt for the financing of the project. However, the values have not deviated a lot from the mean.
The Cost of equity:
The cost of capital has been estimated by multiplying the equity beta with the weight of equity and the value of the risk premium. This value has been calculated for six years in order to get an average value (Exhibit 6). This cost has kept on changing itself based upon the allotted weights to the costs and the variance in the capital structure.
The Weighted Average Cost of Capital:
The weighted average cost of capital has been calculated by taking into account the cost of debt and the cost of unlevered equity. These costs have been added in order to get an average value based upon the capital structure of the company. This value has also been calculated for six years ranging from 2007 to 2010. Then an average value has also been calculated.
The WACC’s have shown adownward trend during the six years. This is mainly because the capital structure has kept on changing itself during the years as more and more debt kept on increasing the value of the overall leverage financing. The deviation has taken place from 21.13% to 16%.
This WACC has inturn been used to calculate other financial values. The value of WACC used to calculate those values is that of 2007 as it is very close to the average value. It is also important to note that the company is planning to rely equally on the debt and the equity financing but the ratios have changed differently. This is mainly because the values of equity and debt as a percentage of the total assets have changed differently.
The Free Cash Flow Estimation:
The free cash flows have been estimated for six years and then an average value has also been taken. These free cash flows have been calculated by calculating the EBIT and then adjusting it against the tax rate. Then the depreciation and the capital expenditure have been subtracted. The change in working capital has been added back to the original value (Exhibit 2).
It is observed that the value of the free cash flows has kept on increasing across the years. In fact, the free cash flows have grown by 7.41% in the six years. This is mainly because the earnings before interest and taxes have increased over the six years.
The Present Value of the Cash Flows:
The present value of the cash flows has been estimated by discounting the cash flows with the equity discount rate. These values have also shown a rising trend. These values have also grown by 7.41%. This is also because of the rising earnings before interest and taxes every year. (Exhibit 2)
The Net Present Value of the Cash Flows:
The net present value of the cash flows after discounting with the equity discount rate comes out to be 6486.74. This is a positive value and shows that if the project tis financed entirely by the equity portion, it would yield a positive stream of cash flows. (Exhibit 5)
The Present Value of the tax Shield:
The present value of the tax shield has been calculated in order to determine the effect that the taxes would have upon the financing of the project. It comesout to be 1503.08. This value is again positive and shows that the portion of the project financed by debt is yielding a positive outcome. (exhibit 5)
The Adjusted Present Value (APV):
The adjusted present value has been estimated by adding both the above parameters to get a final value. This value comes out to be 7989.75 which show that the project would yield a positive outcome if undertaken for the specific horizon time. (exhibit 5)
The terminal Value of the Cash Flows:
The terminal value of the cash flows has been estimated by applying the discounting model to all the cash flows. This model assumes the growth rate of cash flows, the cost of the capital allotted and the value of the cash flow generated in 2012. This value actually tells the worth of the entire project after the horizon time. (Exhibit 2)
This value comes out to be 12841. This positive value shows that the returns generated in the future would be enough to recover the costs and that the returns would add to the positivity of the company’ performance. The positive value is there because the cost of capital is greater than the growth rate of the cash flows.
This value is negative because the growth rate of the cash flows is not significant enough to surpass the cost of capital calculated. This also shows that the returns generated would not yield positive outcomes.
Summing Up:
After calculating the adjusted present value, the present value of the tax shield and the terminal value of the cash flows from 2013 onwards, the entire value of the company can be estimate by adding them up. Their sum comes out to be a positive value i.e. 20975 (exhibit 5). This is a positive value shows that the value of the project is positive enough to cover all the capital expenditures which would be incurred during the project. It also shows that the overall value of the net after costs is positive which shows that the profits would come for the company. This positive terminal value shows that the project is worth consideration.
The Value of the Non-Operating Assets:
The calculations show that the total value of the non-operating assets comes out to be 174. The non-operating assets for this company comprise the marketable securities (both short term and long term) and the investment in affiliated entities. These assets do not contribute to the routine operations of the company and therefore do not play a direct role in the revenue generation or expense generation process of the company. Therefore, these have been categorized as non-operating assets for the company.
The discounted value for these assets comes out to be 144. This value has been calculated by discounting the above value by the weighted average cost of capital this WACC figure has been used as a discount number thought the project.
Value from Synergies:
Exhibit 7 shows the different values which the synergies would generate. These synergies have been looked at isolative and therefore their collective value has been derived by summing the individual synergies up.
It can be seen that the value generated from the saving synergy is 0.8% of the total value generated. Therefore, it can also be analyzed that the value generated through this synergy is not significant enough to have an impact upon the whole value generation [process.
It can also be seen that the value generated from the revenue synergy is 9.95% of the total value. This is a big value and would have significant impact if removed from the portfolio. The company should try to have a collective focus upon this synergy.
If we analyze the impact as a whole, it can be seen that the total value generated through these synergies is 10.74% of the total value of the company. This means a lot for acquisition purposes. This also means that if the company saves upon certain expense or if it tries to generate greater revenue, the acquisition would be fruitful.
 
The Long Term Leverage Structure:
The current leverage structure of the company comprises both debt and equity for financing the assets. Its debt to equity ratio is more than 0.7 which means that the company is relying more on debt than on equity.
The capital structure in 2008 would change because of the introduction of new debt for the acquisition. This would result in greater equity and the D/E value would further decline to 0.38. This decline would be followed by a rise in the D/E value in 2009 because the amortized loan’s value will keep on adding to the existing value.This trend would continue till 2012 as more and more debt will keep on adding to the original value of the assets. This would result in a D/E value of more than 0.5 in 201. So, in 2012, the company would again be financed 50% by debt and 50% by equity.
RECOMMENDATION
It is recommended that:
The optimal discount rate which should be used is 21.13%. The net present value of the project is positive. The adjusted present value of the project is also positive. The value of the entire project also comes out to be positive. However, the net present value of the entire project comes out to be negative. This means that the project tis not worth consideration and the rate of returns being generated through are not enough to surpass the weighted average cost of capital.
Despite of the negative net present value of the project, it should be undertaken. This is because the net present value of the entire project is negative due to the high illiquidity premium assumed. This figure is a controversial and many experts do not advise to use such a high premium. Therefore, the net present value generated is an over-valued figure and should be neglected. This is because the total value of the entire project is positive.
 The revenue stream projected indicates that the free cash flows which would be generated from the project actually would generate an internal rate of return greater than the weighted average cost of capital. It is also important to note that the terminal value of the cash flows is supportive. It is a positive value which further ensures the investors that the project is worth consideration.
APPENDIX 1
(EXHIBIT 1)
REVENUE PROJECTION
Revenue Projections:   2008 2009 2010 2011 2012 GROWTH
Service Revenue   4,194.3 4,781.5 5,379.2 5,917.2 6,331.4 9%
Equipment Revenue   314.8 358.8 403.7 444.1 475.2 9%
Total Revenue     4,509 5,140 5,783 6,361 6,807 9%
Operating Expenses:              
System Operating Expenses 838.9 956.3 1,075.8 1,183.4 1,266.3 9%
Cost of Equipment Sold   755.5 861.2 968.9 1,065.8 1,140.4 9%
Selling, General & Administrative 1,803.6 2,056.2 2,313.2 2,544.5 2,722.6 9%
EBITDA     3,398 3,874 4,358 4,794 5,129 9%
Depreciation & Amortization 705.2 804.0 867.4 922.4 952.9 6%
EBIT       4,103 4,678 5,225 5,716 6,082 8%
Interest Expense     226 257 287 314 335 8%
EBT       3,878 4,420 4,938 5,402 5,748 8%
Tax Rate     40.0% 40.0% 40.0% 40.0% 40.0% 0%
NI       2,327 2,652 2,963 3,241 3,449 8%
Working Capital Assumptions (1):          
Accounts Receivable   41.67x 41.67x 41.67x 41.67x 41.67x 0%
Days Sales Equip. Rev.   154.36x 154.36x 154.36x 154.36x 154.36x 0%
Prepaid Expenses   1.38% 1.38% 1.38% 1.38% 1.38% 0%
Accounts Payable   35.54x 35.54x 35.54x 35.54x 35.54x 0%
Deferred Serv. Revenue   14.01x 14.01x 14.01x 14.01x 14.01x 0%
Accrued Liabilities   6.85x 6.85x 6.85x 6.85x 6.85x 0%
TOTAL     252 252 252 252 252 0%
Capital Expenditures (2):            
Capital Expenditures   631.3 719.7 867.4 970.1 1,055.0 11%
 
(EXHIBIT 2)
FREE CASH FLOW CALCULATION GROWTH RATE
  2008 2009 2010 2011 2012
EBIT * 1-t 2,462 2,807 3,135 3,430 3,649 8%
Change in Working Capital 23 0 0 0 0  
Depreciation 705 804 867 922 953 6%
Capital Expenditures 631 720 867 970 1,055 11%
FREE CASH FLOWS 1,148 1,283 1,400 1,537 1,641 7.41%
PRESENT VALUE OF THE CASH FLOWS 955 1,067 1,165 1,279 1,365 7.41%
TERMINAL VALUE OF CASH FLOWS FROM 2013 ONWARDS           12,841
 
 
(EXHIBIT 3)
NON OPERATING ASSETS
Marketable Securities 16
Marketable Equity Securities 0
Investments in Affiliated Entities 158
TOTAL 174
DISCOUNTED VALUE OF NON OPERATING ASSETS 144
 
 
(EXHIBIT 4)
LONG TERM DEBT TO EQUITY RATIO
  2007 2008 2009 2010 2011 2012 AVERAGE
Assets 5,612 15,271 15,577 15,901 16,243 16,573 14,196
Liabilities 2,372 2,662 2,969 3,292 3,634 3,964 3,149
O/E 3,240 6,997 6,997 6,997 6,997 6,997 6,371
D/E Ratio 0.732 0.380 0.424 0.470 0.519 0.567 0.516
     
 
(EXHIBIT 5)
APV CALCULATION
    TAX    
    40% INFLOWS AND OUTFLOWS DISCOUNTED INFLOWS AND OUTFLOWS
    Revenue                         (10,961)          10,961.2
  2008 1,148                              1,148 947.974359
  2009 1,283.0                              1,283 1059.12894
  2010 1,400.3                              1,400 1156.004035
  2011 1,537.2                              1,537 1268.978752
  2012 1,641                              1,641 1354.99778
NPV (EQUITY BASED)       $6,486.74
PV OF TAX SHIELD       1503.018182
APV       $7,989.75
TOTAL VALUE       $20,975
NPV (ENTIRE PROJECT)       ($5,785)
PAY BACK PERIOD                        7.82
DISCOUNTED PAYBACK PERIOD                        9.47
 
 
(EXHIBIT 6)
CALCULATION OF WACC  
 
COST OF EQUITY  
equity beta 1.000  
risk free rate 4.50%  
equity risk premium 35.00%  
cost of equity 35.00%  
     
COST OF DEBT  
Total cost of Debt 5.50%  
     
WACC CALCULATION (CURRENT D/E RATIO)  
Cost of Equity 35.00%  
Weight of Equity 0.577267415  
Weighted Average Cost of Equity 20.204%  
Cost of Debt 5.50%  
Weight of Debt 0.422732585  
Tax 40%  
Weighted Average Cost of Debt 0.93001168593593%  
WACC 21.13%  
WACC CALCULATION (D/E 2008)  
Cost of Equity 0.35  
Weight of Equity 0.458188642  
Weighted Average Cost of Equity 16.04%  
Cost of Debt 5.50%  
Tax 0.4  
Weight of Debt 0.541811358  
Weighted Average Cost of Debt 1%  
WACC 17.23%  
WACC CALCULATION (D/E 2009)  
Cost of Equity 0.35  
Weight of Equity 0.449179996  
Weighted Average Cost of Equity 15.72%  
Cost of Debt 5.50%  
Tax 0.4  
Weight of Debt 0.550820004  
Weighted Average Cost of Debt 1%  
WACC 16.93%  
WACC CALCULATION (D/E 2010)  
Cost of Equity 0.35  
Weight of Equity 0.440040145  
Weighted Average Cost of Equity 15.40%  
Cost of Debt 5.50%  
Tax 0.4  
Weight of Debt 0.559959855  
Weighted Average Cost of Debt 1%  
WACC 16.63%  
WACC CALCULATION (D/E 2011)  
Cost of Equity 0.35  
Weight of Equity 0.430780249  
Weighted Average Cost of Equity 15.08%  
Cost of Debt 5.50%  
Tax 0.4  
Weight of Debt 0.569219751  
Weighted Average Cost of Debt 1%  
WACC 16.33%  
WACC CALCULATION (D/E 2012)  
Cost of Equity 0.35  
Weight of Equity 0.422196639  
Weighted Average Cost of Equity 14.78%  
Cost of Debt 5.50%  
Tax 0.4  
Weight of Debt 0.577803361  
Weighted Average Cost of Debt 1%  
WACC 16.05%  
WACC CALCULATION (D/E AVERAGE)  
Cost of Equity 0.35  
Weight of Equity 0.448768958  
Weighted Average Cost of Equity 15.71%  
Cost of Debt 5.50%  
Tax 0.4  
Weight of Debt 0.551231042  
Weighted Average Cost of Debt 1%  
WACC 16.92%  
 
 
(EXHIBIT 7)
   Value from Saving Synergy Value from Revenue Synergy Total Value  Discounted Value
2008 0                                                 156.0         156.0 128.782606
2009 13.4                                                 269.0         282.4 282.4
2010 25.8                                                 387.0         412.8 305.7777778
2011 52.5                                                 570.0         622.5 426.8994984
2012 76                                                 704.0         780.0 672.2016875
TOTAL 167.7 2086 2253.7 1816.06157
% of Total Value 0.80% 9.95% 10.74% 8.66%
  
APPENDIX 2
LIST OF FORMULAS USED IN MS EXCEL
  • =NPV('WACC CALCULCTION'!C7,'VALUE ESTIMATION'!D4,'VALUE ESTIMATION'!D5,'VALUE ESTIMATION'!D6,'VALUE ESTIMATION'!D7,'VALUE ESTIMATION'!D8,'VALUE ESTIMATION'!D9)
  • =IRR(D4:D9)
  • =(C3*'LOAN AMORTAZITION SCHEDULE'!F23*'WACC CALCULCTION'!C16)/'WACC CALCULCTION'!C16
  • =NPV('WACC CALCULCTION'!C19,'VALUE ESTIMATION'!D4,'VALUE ESTIMATION'!D5,'VALUE ESTIMATION'!D6,'VALUE ESTIMATION'!D7,'VALUE ESTIMATION'!D8,'VALUE ESTIMATION'!D9)
  • =RATE(5,0,-E22,I22,0)
  • =(Q27*(1+R27))/('WACC CALCULCTION'!C20-'REVENUE PROJECTION'!R27)

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