Question

Question 3. You need to estimate the market value of South Western Airlines. You have the following forecasts (in millions of dollars) of its profits and of its future investments in new plant and working capital: Years 1 2 3 4 EBITDA 100 120 120 140 Depreciation 10 20 20 40 CAPEX 10 25 40 10 From year 5 onward, EBITDA (EBITDA - Depreciation = EBIT), depreciation, and investment are expected to remain unchanged at year-4 levels in perpetuity. South Western Airlines is financed 50% by equity and 50% by debt. It's cost of equity is 14%, and its cost of debt 6%, and it pays a corporate tax rate of 40%. (a) What is the market value of firm's assets? (b) What is the value of South Western Airlines' equity?

Answer 1

А B с D E F 4 346 347 Post tax Cost of debt = 6% (1 - 40%) 348 Post tax Cost of debt = 3.60% 349 350 Cost of equity = 14% 351 352 WACC = (3.60% 50%) + (14% 50%) 353 WACC = 8.80% 354 355 Year 356 EBITDA 357 Less : Depreciation 358 EBIT 359 Less : Tax 360 NOPAT 361 Add : Depreciation 362 Less: Capex 363 Free cash flow 364 Terminal value 365 Free cash flow + Terminal value 366 Present value / Firm value 367 Value of equity = 921.25. 50% 368 Value of equity = 460.63 369 1 100 10 90 36 54 10 10 54 2 120 20 100 40 60 20 25 55 3 120 20 100 40 60 20 40 40 140 40 100 40 60 40 10 90 1,022.73 1,112.73 55 40 54 921.25 370

Please note market value of debt is not provided hence we have calculated value of equity by dividing in proportion.

B с D E F А 346 347 Post tax Cost of debt = 6% *(1 - 40%) 348 Post tax Cost of debt = 3.60% 349 350 Cost of equity = 14% 351 352 WACC = (3.60% 50%) + (14% 50%) 353 WACC = 8.80% 354 355 Year 356 EBITDA 357 Less : Depreciation 358 EBIT 359 Less : Tax 360 NOPAT 361 Add : Depreciation 362 Less: Capex 363 Free cash flow 364 Terminal value 365 Free cash flow + Terminal value 366 Present value / Firm value 367 Value of equity = 921.25 * 50% 368 Value of equity = 460.63 369 1 100 10 =B356-B357 =B358 40% =B358-B359 2 3 4 120 120 140 20 20 40 =C356-C357 =D356-D357 =E356-E357 =C358-40% =D358-40% =E358*40% =C358-C359 =D358-D359 =E358-E359 20 20 40 25 40 10 =C360+C361-C362 =D360+D361-D362 =E360+E361-E362 =E363/8.8% =C363+C364 =D363+D364 =E363+E364 10 10 =B360+B361-B362 =B363+B364 =NPV(8.8%,B365:E365)