Question

Icarus Airlines is proposing to go public, and you have been given the task of estimating the value of its equity. Management plans to maintain debt at 35% of the company’s present value, and you believe that at this capital structure the company’s debt holders will demand a return of 5% and stockholders will require 12%. The company is forecasting that next year’s operating cash flow (depreciation plus profit after tax at 21%) will be $73 million and that investment in plant and net working capital will be $35 million. Thereafter, operating cash flows and investment expenditures are forecast to grow in perpetuity by 4% a year.

a. What is the total value of Icarus?

b. What is the value of the company’s equity?

Answer 1

Answer :

(a.) Calculation of  Total value of Icarus :

Total Value = (Operating Cash Flow - Initial Investment) / (WACC - growth rate)

Operating cash flow = 73 million

Initial Investment = 35 million

WACC = (Cost of after tax debt * Weight of Debt) + (Cost of Equity * Weight of Equity)

= [5% * (1 - 0.21) * 0.35] + [12% * (1 - 0.35)]

= 1.3825% + 7.8%

= 9.1825% or 0.091825

Total Value = (73 million - 35 million) / (0.091825 - 0.04)

=38 million / 0.051825

= 733.236854799 million or 733.24 million

(b.) Calculation of  value of the company’s equity

Value of Equity = Total Value - Value of Debt

= 733.236854799 million - (733.236854799million * 35%)

= 476.60 million