Question

You need to estimate the value of Laputa Aviation. You have the following forecasts (in millions of dollars) of its profits and of its future investments in new plant and working capital Year Earnings before interest, taxes, depreciation, and amortization (EBITDA) Depreciation Pretax profit Tax at 40% Investment 78 38 40 16 14 98 48 50 20 17 113 118 58 60 24 53 60 24 20 From year 5 onward, EBITDA, depreciation, and investment are expected to remain unchanged at year-4 levels. Laputa is financed 40% by equity and 60% by debt, its cost of equity is 13%, its debt yields 9%, and it pays corporate tax at 40% a. Estimate the company's total value. (Do not round intermediate calculations. Enter your answer in millions rounded to the nearest whole dollar amount.) Total value million b. What is the value of Laputa's equity? (Do not round intermediate calculations. Enter your answer in millions rounded to 2 decimal places.) Laputa's equity million

Answer 1

To estimate the value of the company, present value of the future free cash flows are found at the WACC. Calculation of Free Cash Flows: First free cash flow needs to be calculated using the following formula: Free Cash Flow Operating Cash Flow - Capex - Change in working capital Operating Cash Flow EBIT*(1-T)+Depreciation 10 12 Tax Rate Amount in million$ Year EBITDA Depreciation EBIT Tax expense EBIT (1 Add: Depreciation Operating Cash Flow = EBIT*(1 14 15 16 2 4 113 118 118 38 53 S40.0 $50.0$60.0 $60.0$60.0 ($16.0)(S20.0)(S24.0)($24.0)($24.0) $24.0 $30.0$36.0$36.0$36.0 $38.0 $48.0$53.0 $58.0$58.0 $62.0 $78.0$89.0$94.0$94.0 $0.00 $0.00$0.00 $0.00$0.00 $14.00 $17.00 $20.00 $ $48.00 $61.00 $69.00 $ +depreciation Investment in working capital $22.00 $22.00 $72.00 $72.00 24 Free Cash Flow 26 27 Calculation of WACC: Formula for WACC is given as: WACC r(E) xW(E) r(D) (1-t) x w(D) Where, r(E) and r(D) are cost of equity and cost of debt, w(E) is weight of equity and W(D) is weight of debt and t is the tax rate 31 32 Tax rate Source of capital Debt Weight(w) 35 36 37 Cost(c 60%) 9.00% 40%) 13.00% WACC 39 8.44% E36* D36+E35 (1-D33)*D35 Hence WACC is 8.44% 42

43 Calculation of value of the company: All amount in million $ Year Free Cash Flow 47 1 2 4 $48.00 $61.00 $69.00 $72.00 $72.00 49 Since cash flow after year 4 is constant, value of terminal cash flow at the end of year 4 can be calculated as follows Terminal cash flow in year4 FCFs/w 51 52 53 $853.08 148/D41 All amount in million $ Year Free cash flow Horizon value WACC Present Value Factor (P/F,i,n Present value of cash flows Present value of cash flows 1 2 4 $48.00 $61.00 $69.00$72.00 $853.08 57 8.44% 59 0.92 0.85 0.78 0.72 $A4.26 $51.87 $54.11$668.99 61 $819.24 -SUM(E60:H60 63 Value of Firm Value of Debt Value of Equity $819.24 million $491.54 million $327.70 million Hence Value of the firm is $819.24 million Value of Equity $327.70 million
Formula sheet

A	B	C	D	E	F	G	H	I	J	K	L
2
3
4		To estimate the value of the company, present value of the future free cash flows are found at the WACC.
5
6		Calculation of Free Cash Flows:
7
8		First free cash flow needs to be calculated using the following formula:
9		Free Cash Flow = Operating Cash Flow - Capex - Change in working capital
10		Operating Cash Flow = EBIT*(1-T)+Depreciation
11
12		Tax Rate	0.4
13
14		Amount in million$
15		Year	0	1	2	3	4	5
16		EBITDA		78	98	113	118	=H16
17		Depreciation		38	48	53	58	=H17
18		EBIT		=E16-E17	=F16-F17	=G16-G17	=H16-H17	=I16-I17
19		Tax expense		=-E18*$D$12	=-F18*$D$12	=-G18*$D$12	=-H18*$D$12	=-I18*$D$12
20		EBIT*(1-T)		=SUM(E18:E19)	=SUM(F18:F19)	=SUM(G18:G19)	=SUM(H18:H19)	=SUM(I18:I19)
21		Add: Depreciation		=E17	=F17	=G17	=H17	=I17
22		Operating Cash Flow = EBIT*(1-T)+depreciation		=E20+E21	=F20+F21	=G20+G21	=H20+H21	=I20+I21
23		Investment in working capital		0	0	0	0	0
24		Capex		14	17	20	22	=H24
25		Free Cash Flow		=E22-E23-E24	=F22-F23-F24	=G22-G23-G24	=H22-H23-H24	=I22-I23-I24
26
27
28		Calculation of WACC:
29		Formula for WACC is given as:
30		WACC = r(E) × w(E) + r(D) × (1 – t) × w(D)
31		Where, r(E) and r(D) are cost of equity and cost of debt, w(E) is weight of equity and W(D) is weight of debt and t is the tax rate
32
33		Tax rate	=D12
34		Source of capital	Weight(w)	Cost(c)
35		Debt	0.6	0.09
36		Equity	=1-D35	0.13
37
38		WACC	= r(E) × w(E) + r(D) × (1 – t) × w(D)
39			=E36*D36+E35*(1-D33)*D35	=E36*D36+E35*(1-D33)*D35
40
41		Hence WACC is	=D39
42
43
44		Calculation of value of the company:
45
46		All amount in million $
47		Year	0	1	2	3	4	5	…
48		Free Cash Flow		=E25	=F25	=G25	=H25	=I25	…
49
50		Since cash flow after year 4 is constant, value of terminal cash flow at the end of year 4 can be calculated as follows:
51		Terminal cash flow in year 4	=FCF5/w
52			=I48/D41	=I48/D41
53
54		All amount in million $
55		Year	0	1	2	3	4
56		Free cash flow		=E48	=F48	=G48	=H48
57		Horizon value					=D52
58		WACC	=D41
59		Present Value Factor (P/F,i,n)		=1/(1+$D58)^E55	=1/(1+$D58)^F55	=1/(1+$D58)^G55	=1/(1+$D58)^H55
60		Present value of cash flows		=E56*E59	=F56*F59	=G56*G59	=(H56+H57)*H59
61		Present value of cash flows	=SUM(E60:H60)	=SUM(E60:H60)
62
63		Value of Firm	=D61	million
64		Value of Debt	=D63*D35	million
65		Value of Equity	=D63-D64	million
66
67		Hence Value of the firm is	=D63	million
68
69		Value of Equity	=D65	million
70