calculate the total capital for the year 2002
Cash Flow Model is the fundamental method for valuation which is used to estimate the desirability of an investment opportunity. Discounted cash flow (DCF) analysis uses future free cash flow projection and discounts them using the weighted average cost of capital (WACC) to arrive at a present value, which will be used to assess the potential investment. Thus, in order for us to discount the future cash flows, we must first calculate the WACC; which is minimum required rate of return that an investor will expect to receive when investing money in the firm. The required information regarding JetBlue’s WACC calculation is not available in the case, so it was not accessible for us it to calculate. Therefore, to calculate the cost of debt for a private company like JetBlue, an analysis of comparable companies’ cost of debt is used. So, in order of getting an appropriate valuation, we must depend on terminal value assumptions. To estimate terminal value, comparable multiples will be used. In the Excel Sheet Q2 & 5 determine the terminal value estimates using different multiples and growth models. Moreover, by using the WACC (9.74%) that was calculated in question 4, the cash flows will be as follows.
· The first step to take, is that earnings before interest and tax (EBIT), net operating profit after tax (NOPAT), depreciation and capital expenditure (CAPEX) should all be taken directly from Exhibit 13.
· Second step, change in the net working capital (NWC) was calculated by taking the numbers from Exhibit 13 and then subtracting the old year from the most recent year. For example, 2002 change in NWC is (63.5-33.9) = 29.6 which is approximately 30 and the rest will be done for every year till 2010.
· Free cash flows for all years from 2002 till 2010 are calculated by using the following formula (NOPAT + Depreciation – CAPEX – Change in NWC).
· WACC, weighted average cost of capital which is discount rate was taken directly from Q4 in the Excel sheet.
· To calculate present value of cash flows, we took the free cash flow of the particular year divided by (1+WACC) ^n.
· Then to calculate the discounted value of the forecasted period, we used the sum function by adding all the present value of cash flows.
· Book debt for 2001 was taken from Exhibit 2 in the book which was calculated as follows (Short term borrowings +Current maturities of long term debt +long term debt) which is equal to (28.781+54.985+290.665) = $374 million.
· Convertible redeemable preferred stock and book equity value for 2001 were both directly taken from Exhibit 2.
· To calculate the total capital for the year 2002, we added 2001 book debt, convertible preferred stock, book equity, capital expenditure and change in net working capital and then subtracted the depreciation. As for the rest of the years, we took the previous year’s total capital and add to it CAPEX and change in NWC and subtract the depreciation.
· Shares outstanding is 40.6 million shares where 35.1million shares was taken from the footnotes, and that is added to the 5.5 million shares planned for the IPO. Both numbers were taken directly from the book.
· In order to calculate the terminal value, two methods can be used: 1) the Perpetuity Growth Model, which assumes that the free cash flow (FCF) will grow at the same rate to infinity (forever). This usually gives us a higher terminal value than the exit multiple model (EMM). 2) The Exit Multiple Model (EMM) on the other hand estimates the cash flow using multiple earnings. Where the price to earning (P/E) ratio, EBIT, and EBITDA are commonly used approaches to calculate terminal value.
· For the terminal values estimate, we first started with the constant growth model which tends to be low. Typically, the perpetuity growth rate is between the historical inflation rate of 2%-3% and the historical gross domestic product (GDP) growth rate of 4%-5%. Therefore, we used two growth rates, one at 3% and the other at 5%. The perpetual growth method that is used to calculate the terminal value formula is considered the preferred method as it assumes the business will continue to generate free cash flow (FCF) at a normalized state forever (perpetuity).
· When the growth rate is 3%, the price is $6, and when the rate is 5%, the price is $23. We first calculated the terminal value (TV) for 2010 by using the following formula: TV = (FCFn x (1 + g)) / (WACC – g). To calculate the TV for 2002, we took the 2010 terminal value divided by 1 plus the WACC to the power of 9 (indicating the 9 years from 2002 and 2010).
· The rest of the calculations are analyzed more in question 2 above. The Terminal Value using the EBITDA and EBIT multiples can be found in the Excel sheet Q2&5.
What need to be done first, when using the constant-growth model, we can observe that if JetBlue is going to shift a steady growth in the year 2001, then the stock is not worth that much. This further suggests that using a constant-growth model method for planning period will probably be too short to value JetBlue. Therefore, it will be better to calculate the terminal values based on EBIT and EBITDA multiples as both will create a broader estimate range. Calculating the multiples based on the average of the industry has concerns such as the effects of outliers that lead to misleading figures and the lack of truly comparable companies to base the calculations on. As it can be seen in Q2&5 in the attached excel sheet under the trailing EBIT and EBITDA multiples that taking the average or median of all airlines decreases the terminal value as this took the outliers into consideration. While when taking the average or median for the low fare airlines (which are more closely comparable to JetBlue as it is considered a low fare airline itself) the terminal value increases. We get even better terminal value estimations and reasonable valuations when just using the Ryanair’s multiple to get the terminal value as it serves as good comparable to JetBlue, since the cash flows for JetBlue are best compared to Ryanair. JetBlue’s terminal value multiple should increase in 2010, also it will increase its growth that are currently for Ryanair.
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