VALUATION OF AIR THREAD CONNECTIONS Case Solution
Secondly, this acquisition would help American Cable Communications to expand into the business market. This would help in the cost efficiency and network utilization. Furthermore, it would have the beneficial effect of reducing the risks associated with the operations of ACC. Thirdly; American Cable Communications was in a much stronger position to add value to AirThread Connections.
A preliminary study that had been conducted by Rubinstein and Ross had estimated that the use of fiber lines of American Cables could have saved the back haul costs of AirThread by 20%. Apart from this strategic fit, R&R also believed that the company could gain higher level of debt to finance the acquisition of AirThread Connections.
Unlevered Cost of Capital
In order to compute the unlevered cost of capital, we have first generated the asset beta of all the comparable companies as shown in exhibit 7 of the case. The average asset beta has been taken to compute the unlevered cost of capital for AirThread Connections, which is 0.82 as shown in exhibit 1. Using the asset beta of 0.82, and the other inputs of the CAPM model we have calculated the cost of equity from year 0 to year 11. The range of WACC are shown in exhibit 2 but we will use the unlevered cost of capital of 8.33% without any effect of cost of debt since we are using the leveraged buyout approach to value AirThread Connections.
Unlevered Free Cash Flows
Next, we have calculated the forecasted unlevered free cash flows without any effect of debt and interest rate for the period of 2008 to 2012 as shown in exhibit 3. The formula to compute these cash flows is as follows: EBIT*(1-TAX %) + Depreciation and Amortization – changes in net working capital – changes in capital structure.
Present Value of Cash Flows
Using the unlevered cost of capital of 8.33%, we have calculated the PV of unlevered cash flows, which is $ 1150.5 million.
Present Value of Interest Tax Shields
First, we have computed the interest payments for the period of 2008 to 2012 based on the debt level of four times of EBITDA of 2007, which is calculated to be $ 4133 million. The interest and principle payments are shown in exhibit 4. The PV of tax shield has been calculated based on the cost of debt of 5.50% as provided in exhibit 6. The PV of tax shield is 325.1 million as shown in exhibit 4.
The debt to equity ratio for the industry is 39.1% as shown in exhibit 2 in the appendices. The asset beta of 0.82 has been converted to equity beta using the de-gearing formula. The equity beta is 1.13. Using the inputs, we have the WACC for ATC of 8.06% as highlighted in exhibit 2 in the appendices.
ATC’ Terminal Value
The terminal value for ATC has been calculated based on the industry debt to equity levels and the WACC of 8.06%. The terminal growth rate has been calculated using the Logest function in excel based on the level of total assets historically. This rate is 1.8%. The terminal value of the company has been computed to be $ 4487 million as shown in exhibit 6.
Value of Non Operating Assets
The equity in earnings in affiliates is $ 90 million in 2007 and the industry PE ratio is 19.90 as shown in exhibit 5. The value of non-operating assets is $ 1718 million as shown in exhibit 6.
Based on the analysis performed in the steps above we have calculated the Enterprise Value of ATC by summing up the PV of the unlevered free cash flows, PV of the tax shield, PV of terminal value and the value of non operating assets. The enterprise value for ATC is $ 7681 million as shown in exhibit 6 in appendices.
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