CASE STUDY HOMEWORK CORPORATE FINANCE
The Situation: In 2010 a new company was created in order to enter into the food industry. They spent many months in studying the market, engineering the products and the commercial strategy, find out the production plants. At the end of 2010 the business plan is ready and the company has already participated to an exhibition where many potential customers said to be very interested to the project. The problem: A private equity institution gets in touch with the company in order to buy 30% of the company buying new shares. The company wonders about the value of such shares, that is why the company asks a consultant to provide an estimation. The ...view middle of the document...
In the forecast "EBITDA" was twice times mentioned, we assumed for our further calculations that the first "EBITDA" is the "EBIT" Furthermore with the "EBIT", we calculated the depreciation. However, for our DCF (Discounted Cash Flow) Valuation, the data of the year 2010 is not necessary. With reference to our BBB rated American bond, we discounted it, on an assumption that the valuation was done by February 2011. In particular we thought about starting from the first quarter of the year, which leads to a value of 0.75 of maturity for our first discounted Cash-flow. The remaining ones could be taken from the calculation table at the end of this report. The present value, is the value of a private company, it is calculated by discounting the cashflows. The discounted rate reflects the risk in a firm and the debt. The company itself wants to sell 30% of their shares to a private equity investor. Present Value calculation:
WACC (Weighted Cost of Average) Before we are able to calculate the fair value of the firm, we have to consider several components. For calculating the WACC, we have to consider three main components: a) cost of equity, b) cost of debt and c) capital structure. Cost of Capital: It is sometimes called, in an economic context, discount rate. The cost of capital is a market driven number. That is the reason why we use market value weights. In particular it is the expected rate of return that the market requires in order to attract funds to an investment. It is often called as opportunity costs. Being more precise it means that an investor will not invest in a particular asset if there is a more attractive substitute. Cost of Capital = Cost of Equity (E/(D+E)) + After-tax Cost of Debt (D/(D+E)) Cost of Debt: It is the cost of debt financing to company, when the company takes out a loan or issues a bond. It depends on risk factors. It is calculated by:
Cost of debt=Risk free rate + default premium There are two well know methods to determine the cost of debt: YTM: It is the annual return that an investor will earn, when he holds the bond till maturity. The yield to maturity on an issued bond has the advantage of being a market-determined rate. It will be skewed by any special features that the bond may have and the degree to which the bond is secured, relative to other debt Debt Rating Approach: This method is used, if there is no current market price available. This method can be used to estimate the before-tax cost of debt. The before tax cost of debt relies on a company's debt rating, we estimate it by using the yield on comparable rated bonds for maturities that closely match that of the company's existing debt. In our case study we used a BBB rated Us corporate bond, to obtain our before tax cost of debt, for our WACC calculation:
WILLIS GROUP HLDGS PUBLIC LTD Price: Coupon (%): Maturity YTM Current Yield Fitch Ratings: Coupon First Coupon Type:...