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 30% 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 11%. The company is forecasting that next year’s operating cash flow (depreciation plus profit after tax at 40%) will be $68 million and that investment expenditures will be $30 million. Thereafter, operating cash flows and investment expenditures are forecast to grow in perpetuity by 4% a year.

What is the value of the company’s equity? (Do not round intermediate calculations. Enter your answer in millions rounded to 1 decimal place.)

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 30% 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 11%. The company is forecasting that next year’s operating cash flow (depreciation plus profit after tax at 40%) will be $68 million and that investment expenditures will be $30 million. Thereafter, operating cash flows and investment expenditures are forecast to grow in perpetuity by 4% a year.

Explanation / Answer

Free cash flow = OCF - Capital expenditures
= 68 - 30 = $38 million

WACC = 30% * 6% * (1-40%) + 70% * 11% = 8.78%

a) Value of the firm = Free cash flow / (WACC - g)
= 38 / (8.78% - 4%) = $794.98 million

b) Company has 70% equity
So value of equity = 70% * 794.98 = $556.49 million

Related Questions

Navigate

• Browse (All)
• Browse I
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.