Xedia And Silicon Valley Bank (A) Case Study Analysis
The case report demonstrates the deal terms of a bridge loan between Xedia and Silicon Valley Bank. Xedia is a leading equipment manufacturer, which provides high speed internet service, whereas the Silicon Valley Bank provide credit facilities to young companies. The Bank’s strategy comprises of targeting niche firms operating in the industry of technology and life science. The Bank was established in 1983, and provides its services to companies that raise money form Venture Capital. Its services comprise of Bridge loans, working capital lines of credit, and equipment financing and asset acquisition loans. The service division of the institution includes: business banking, cash management, factoring, equipment loan and asset based lending. In addition, the institution grants loan to young companies with an average sales of $5 million and loan amount of $1 million.
Xedia was financed by Jens Montanana and Ashley Stephenson in the year 1993. The major competitors of the organization include: Cisco System, Ascend and 3com. The organization sells its product through Bay Networks and its major source of revenue is income from royalties.Therefore, the organization was reinvented in 1996 with the $5 million of royalty income received from Bay Networks. In order to take advantage of the growth in traffic, the organization repositioned itself and entered the internet market.
In order to fund daily operations, the organization needs to obtain bridge loan until it raises the next round of equity financing. To obtain the loan, the organization has approached SVB. However, taking under consideration the negative cash flows and loss from operations of the company, raising additional finance to run day to day operations has become increasingly difficult.
SVB’S Decisions to Make the Loan:
To evaluate the decision to grant the loan to Xedia, it was assumed that the SVB will grant loan at an annual interest rate of 5% which is the weighted average cost of the company i.e. the minimum return SVB would demand. In order to calculate WACC, the five year rate of Government bond of the last quarter of 1997 have been used. The market rate of return is estimated to be 13% which is calculated using the proportion of the S&P 500 Index with the Real GDP of the last quarter of 1997 AS Stock Prices are correlated with GDP (wise-owl.com, 2020).
In addition, in absence of the cost off debt it is assume that the cost of debt is equal to the risk free rate of return. The market value of equity is estimated to be 174.481 million USD, which is the shareholder’s equity assuming the book value of the equity is its market value. Moreover, the market value of debt amounting to 1312.8 million USDis used, which is provided in Exhibit 4 of the case study. Moreover, in absence of the equity beat for Commercial banks, the current equity beta for SVB has been used.
It is estimated that the bridge loan will be granted for a tenure of 3 years and a loan amortization schedule demonstrating the annual interest payments have been established. It is evaluated that the company will not be able to pay off the interest payments in the first and second year of the loan period due to negative cash flows.
In order to evaluate the business’s ability to pay off the loan borrowed to SVB, the future cash flows for Xedia has been forecasted using a discount rate of 15.65%. The discount rate has been calculated using a 13% market rate and beta of 2.42 i.e. average of the three competitors of the organization which includes Cisco System, Ascend and 3com Corporation. Moreover, the cost of debt is assumed to be the risk free rate of return i.e. the 5 year government bond rate. In absence of the information related to market value of debt and equity, it is assumed that the book value of the equity and debt is its market value……………………………
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