Question

After reviewing the entire case, determine Wright’s firm value, intrinsic share price, and intrinsic price-to-earnings ratio for both West Airlines and jetGreen Airlines. Then compose a one-page memo from Orville Wright to Amelia Earhart on December 31, 2018. State your investment recommendation and your rationale for making it.

Required:

1. Determine Wright's firm vlaue, intrinsic value, share price, and intrinsic price-to-earnings ratio for both West Airlines and jetGreen Airlines.

2. Compose a one-page memo from Orvill Wright to Amelia Earhart on December 31, 2018. State your investment recommendation and your rationale for making it.

	West	jetGreen
Market Share Price
EPS
Market P/E Ratio
Net income
EPS
Number of shares
Share Price
Firm Value
EBIT
Net of tax
Net EBIT
PPE purchase
Depreciaiton
Net investment
	West	jetGreen
Net EBIT
Net investment
FCF--2018
FCF--2019
FCF--2020
FCF--2021
FCF--2022
TV
West	FCF	P.V. Factor	PV of FCF
FCF--2019
FCF--2020
FCF--2021
FCF--2022
TV
Firm Value
jetGreen	FCF	P.V. Factor	PV of FCF
FCF--2019
FCF--2020
FCF--2021
FCF--2022
TV
Firm Value
	West	jetGreen
Firm Value
Bonds payable
Common equity value
Number of shares
Intrinsic share value
EPS
Intrinsic P/E Ratio

Orville Wright analyzes the airline industry. Investors with an interest in or lending to airlines seek his advice and recommendations. Amelia Earhart, Orville's wealthiest client, asked him to determine which of two airlines offered her the better investment opportu- nity at the end of 2018. Amelia's interest centered on two of the so-called discount airlines. West Airlines was created after the United States deregulated the airline industry. Prior to deregula tion, airlines priced tickets on a cost-plus basis. This arrangement allowed carriers to recover all of their costs and earn acceptable profit margins and returns on investment. In this environment older legacy carriers, such as American, Delta, and United, did not have an incentive for containing costs. The air carriers merely passed on those cost to their passengers in the form of ever escalating ticket prices. Mounting pressure from the public spurred Congress to substantially deregulate the passenger airline industry in the late 1970s. Sensing an opportunity to capitalize on airline deregulation, investors formed West Airlines. This post-regulatory start-up's business model focused on containing costs, such as non-unionized labor, and passing the cost savings on to their passengers in the form of lower ticket prices. The strategy proved financially successful as West gained market share from the legacy carriers and stimulated demand in consumers who previously did not utilize air travel. The financial success of West spawned other discount competitors the most successful of which was jetGreen Airlines. Amelia Earhart wanted to purchase stock in either West or jetGreen. She paid Orville Wright for his analysis and recommendation. Orville begins his assignment by gathering the most recent financial statements for West and jetGreen Airlines (amounts in millions, except earnings per share): WestjetGreen 2018 Income Statements: Revenues Salaries expense Fuel expense Other operating expenses Operating income Interest expense Pretax income Income tax expense Net income Earnings per share 2018 $4,000 1,420 1,075 $8,000 2,450 2,040 1,860 360 1,500 600 300 120 $ 180 1.50 $900 $ .45 Balance Sheets: Cash Accounts receivable Equipment, net of depreciation Other assets Total assets 12/31/18 12/31/1 500 800 6,500 1200 $9,000 150 350 3,600 $5,000 串300 3,000 1,200 $ 600 4,000 2,000 2.400 9,000 Current liabilities Bonds payable Common stock Retained earnings Total liabilities and s/equity $5,000 2018 2018 Statements of Cash Flows: Net income + Depreciation expense Change in current accounts Cash flows from operating activities $900 200 110 990 180 90 (70 200 Cash flows from investing activities (160) Purchase of equipment 500) Cash flows from financing activities Payment of dividends (350 $140 C40) 串50 Net change in cash Wright began by determining each firm's free cash flow for 2018. He projected that West's free cash flows would increase by $50 million annually during the forecast period Wright concluded that jetGreen will realize annual free cash flows of $20 million annually for the forecast period. The analyst is confident about estimating the airlines free cash flows through 2022. After that four-year forecast horizon, however, Wright concluded that it would be necessary to calculate the terminal values of the firms' free cash flows Chapter 7 Financial Statement Analysis lI 188 Wright estimated that each airline will grow 2% annually beyond 2022 because both discount airlines will become mature firms by that time. The analyst thinks that West will retain a more conservative capital structure than jetGreen in the long-run. Consequently, Wright estimated West's long-term weighted average cost of capital at 7% and jetGreen's weighted average cost of capital at 8%. Wright gathered the following present value of money factors to help him value the firms Period 2% 7% 8% 92593 85734 98039 9611787.344 8 9423281630 .92385 7629073503 9057371299 68058 93458 3 4 79383 Finally, Wright noted the current market price for each air carrier's stock on December 31, 2018. Southwest Airlines closing share price for 2018 was $6.40, while jetGreen closed at S18.10 per share. Required: 1. Determine Wright's firm value, intrinsic share price, and intrinsic price-to- earnings ratio for both West Airlines and jetGreen Airlines

Answer 1

answer of Q1:

PART 1:

Wright"s firm value= equity+debt+interest-value of assosiate company-cash

now with reference to the data given below:

FIRM VALUE OF SOUTH WEST AIRLINES=7680+4000+360-500$

=11,540$

FIRM VALUE OF JET GREEN AIRLINES=16,290+3000+300-150$

=19,440$

HERE FROM ABOVE VALUE WE CAN SAY THAT SOUTH WEST AIRLINES FIRM VALUE IS HIGHER THAN GREEN AIRLINES COMPARED WITH ITS MARKET CAPITALISATION.

A) to get market captialisation of equity=share price*shares outstanding

for south west arlines=6.40$*1200$(other asset)

=7680$

for jet green airline=18.10$*900

=16,290$

B) Total debt

for south west airlines=4000$ (bonds)

for jet green airlines=3000$(bonds)

C) minority interest

for south west airlines=360$

for jet green airlines=300$

D) cash and cash equivivelents

for south west airlines=500$

for jet green airlines=150$

PART 2; FOR

INTRINSIC SHARE PRICE WE REQUIRED

WACC FOR BOTH COMPANIES ARE 7% AND 8%

CASH FLOW/WACC

FOR SOUTH WEST AIRLINES=140/7%=980$

JET GREEN=50/8%=400$