Icarus Airlines is proposing to go public, and you have been given the task of e

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 36% of the company’s present value, and you believe that at this capital structure the company’s debtholders will demand a return of 6% and stockholders will require 13%. The company is forecasting that next year’s operating cash flow (depreciation plus profit after tax at 40%) will be $74 million and that investment expenditures will be $36 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? (Do not round intermediate calculations. Enter your answer in millions rounded to the nearest whole dollar amount.) b. What is the value of the company’s equity? (Do not round intermediate calculations. Enter your answer in millions rounded to 1 decimal place.)

Explanation / Answer

Let Interest on Debt = x

So, Return available for equity = 60%(87.33-x)

= 52.4 - 0.6x

Let total Capital Structure is 100 millions

Debt (36%) = 36

Rest is equity = 64

Return for debt @ 6% = 36*6% = 2.16

Return available for Equity @ 13% = 64*13% = 8.32

a) If return is 8.32 then total Capital is 100

If return is (52.4-.6x) the total Capital is = 100/8.32 *(52.4-0.6x)

b) If debt return is 2.16 then total Capital is 100

If debt intt is x then total Capital is = 100/2.16*x

100/2.16*x = 100/8.32 *(52.4-0.6x)

832x = 11318.4 - 129.6x

x = 11.77

So, Debt is 11.77/6% = 196.17

Equity is = 196.17/36*64 = 348.75

Total Capital = (196.17 + 348.75) = 544.93 millions

Operating Cash Flows after Tax 74 Tax Rate 40% Operating Cash Flows before Tax 123.3333 Investment Expenditure 36 Net Profit before tax 87.33333

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