Air Thread Questions
1. Considering valuation methodologies based on capital structure assumptions.
There are two methods that can be used in the valuation of Air Thread Connection. The two methods are Weighted Average Cost of Capital (WACC) and APV model. The WACC valuation model is determined by the average rate of return suspected by the company to compensate its various investors. The main focus for the computation of the WACC is based on the proportion of the capital funding of the organization as the sources of its finance.
However, the APV method is used to compute the valuation of the company on the basis of its all equity based finance. This method is most effective in the case when there the company is under extreme amount of debt, and the leveraged buyout option is being considered.
2. Understanding the underlying differences in WACC and APV models
APV method of valuation assumes that the company is operating over complete equity financed capital structure i.e. there is not debt portion in its financial structure. Therefore the WACC is computed only by considering the cost of the equity, and then computing the tax shield or other discounted non operating assets. This method of valuation is effective when the capital structure of the organization changes significantly over the time frame of the investment. In this way, the value of tax shield can be easily determined.
On the other hand, WACC is determined as the weighted average discount rate that is being used for the valuation of the company. This method assumes that the capital structure of the company remains constant throughout its investment time frame. This method compute the discount rate of the company on basis of after tax cost of capital of each sources of the company i.e. Debt and Equity etc. the interest shield does not to have to be computed separately to compute the tax shield arising on the basis of the interest.
3. Estimating the impact of capital structure changes and assumptions on the determination of the cost of capital
As the company raises it debt portion in its capital structure, the interest expense of the company is also get increased. Lenders of the company anticipate that the company will not be able to fulfill its financial obligation and result in the inability t pay its debt. On the other hand, stockholders also lose the confidence in the company. If the interest of the company increases, it will result in the decrease of EPS and depreciating of the stock price, the worst outcome will be the company goes bankrupt.
However, the optimal capital structure is considered the one, when the combination of the portion of equity and debt are in equilibrium which not only increase the earning of the company, but also increase its share price, resulting in reducing the WACC of the company.
4. Forecasting cash flows
Please refer to excel sheet
5. Forecasting the value of interest tax shields
In the process of calculation of the interest tax shield, the first step is discount interest tax shields at the discount rate for AirThread Connections debt, which is 5.5% currently. And the discounted rate for the tax shields result in the 5.50%. The NPV of tax shield is computed as 286.78.
6. Considering the impact of synergies, non-operating assets, and terminal value growth assumptions on valuations.
AirThread seems much cheaper without the synergy, but free cash flow are reducing over the periods which determine that the company requires ACC in order to obtain the benefit which are being arise from the reduction of the cost of operating and the increase in the market value of the company share. We have to analyze the synergy that is being created by the merger of the two companies and the benefits arising from them.
However, we see the NPV of the company is much higher with the synergy as compared to the NPV without the synergy. This could lead to the conclusion that if both the companies merge, there could be an opportunity that huge revenue might incur which increase the company value and its market capitalization.
7. Make pro forma statements for the next three years?
Refer to excel sheet