Free Cash Flow and Total Value
1 – Methodological Approach
In this case, American CC – the intended acquirer of AirThread Connections- will use leveraged buyout (LBO) model, which means the company will finance the acquisition through bank loan or some other borrowing methods. Hence, the debt-to-equity ratio will change in time. Since we will need to estimate the discount rate any time the capital structure changes, neither WACC nor APV would be reliable alone. Therefore, Ms. Zhang should use the combination of WACC and APV methods.
As stated above, ACC will use the Leverage buy out (LBO) approach, which means that the debt to equity ratio of AirThread will not be the same from 2008 to 2012, so APV approach would be more suitable to valuate the cash flows between 2008 and 2012.
After 2012, AirThread will de-lever to industry norm and thus, they will have a target leverage ratio; therefore WACC is best to estimate the terminal value.
Finally, regarding the valuation of non-operating investments in equity affiliates, due to limited data, market multiple approach would be better to use.
2 – Valuation of AirThread
Regarding the estimation of the long-term growth rate, Ms. Zhang knows that the long-term growth rate would be a function of the company’s return on capital (ROC) and reinvestment rate. According to the definition given in the case, ROC is defined as net operating profits after taxes divided by the book value of equity and debt. Since, there is not enough data on book value of the comparable firms; we can use the market value of equity and debt for estimation. AirThread’s ROC should be in line with its peers at 3.0%, calculated below :
Equity Mrkt Debt/ Debt Net
Comparable Companies: Value Equity Value Income ROC
Universal Mobile 65,173 92.3% 60,160 3,794 0.030
Neuberger Wireless 94,735 41.4% 39,261 4,103 0.031
Agile Connections 37,942 24.1% 9,144 (30) (0.001)
Big Country Communications 47,314 31.7% 15,003 3,384 0.054
Rocky Mountain Wireless
In this case, American CC – the intended acquirer of AirThread Connections- will use leveraged buyout (LBO) model, which means the company will finance the acquisition through bank loan or some other borrowing methods. Hence, the debt-to-equity ratio will change in time. Since we will need to estimate the discount rate any time the capital structure changes, neither WACC nor APV would be reliable alone. Therefore, Ms. Zhang should use the combination of WACC and APV methods.
As stated above, ACC will use the Leverage buy out (LBO) approach, which means that the debt to equity ratio of AirThread will not be the same from 2008 to 2012, so APV approach would be more suitable to valuate the cash flows between 2008 and 2012.
After 2012, AirThread will de-lever to industry norm and thus, they will have a target leverage ratio; therefore WACC is best to estimate the terminal value.
Finally, regarding the valuation of non-operating investments in equity affiliates, due to limited data, market multiple approach would be better to use.
2 – Valuation of AirThread
Regarding the estimation of the long-term growth rate, Ms. Zhang knows that the long-term growth rate would be a function of the company’s return on capital (ROC) and reinvestment rate. According to the definition given in the case, ROC is defined as net operating profits after taxes divided by the book value of equity and debt. Since, there is not enough data on book value of the comparable firms; we can use the market value of equity and debt for estimation. AirThread’s ROC should be in line with its peers at 3.0%, calculated below :
Equity Mrkt Debt/ Debt Net
Comparable Companies: Value Equity Value Income ROC
Universal Mobile 65,173 92.3% 60,160 3,794 0.030
Neuberger Wireless 94,735 41.4% 39,261 4,103 0.031
Agile Connections 37,942 24.1% 9,144 (30) (0.001)
Big Country Communications 47,314 31.7% 15,003 3,384 0.054
Rocky Mountain Wireless