Management plans to maintain debt at 30 percent of the company s present value and you believe

QUESTION

Company Valuation. 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 percent of the company”s present value, and you believe that at this capital structure the company”s debt holders will demand a return of 6 percent and stockholders will require 11 percent. The company is forecasting that next year”s operating cash flow depreciation plus profit after tax at 40 percent) will be $68 million and that investment expenditures will be $30 million. Thereafter, operating cash flows and investment expenditure are forecast to grow by 4 percent a year.a. What is the total value of Icarus?b. What is the value of the companys equity?
a) Debt=30% Equity=70% Debt holder % return= 6% After tax cost of debt=6%*(1-0.4)=3.6% Stockholdersreturn= 11% Tax rate= 40% Next year cash flow =operating cash flow depreciation plus profit after tax at 40 percent -investment expenditures =68-30=$38 million WACC of the company=weight of equity*stock holder return + weight of debt * after tax cost of

debt = (70/100)*11% + (30/100)*3.6%=8.78% (WACC) Dividend next year=$38 million Present Value of Dividend=Dividend next year/(rate of return-growth rate) Value of Icarus=38/(8.78%-4%)=$795million b) value of equity = (1-30%)*795=$556.5

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