Question

You are working with a teammate to value Blue Dot Limited. You have developed the following FCF to Firm projection (including the terminal value at the end of Year 4): FCF to Firm Year $mm 1 40 2 45 3 50 4 520 Your teammate mistook the above cash flows as FCF to Equity and applied Blue Dot’s cost of equity as the discount rate, and arrived at an estimated equity value of $410 million, or $4.10 per share. Blue Dot’s non-operating assets include cash of $50 million, and a 40% interest in a 15-year joint venture (the “JV”). The JV is expected to generate cash flow of $25 million at the end of Year 1, and thereafter cash flow will increase by 2% per year. The JV has a cost of capital of 13%. Blue Dot has one outstanding debt, with a book value of $115 million (market value $120 million). Blue Dot’s cost of debt is 5%. The tax rate is 25%. Blue Dot has 100 million shares outstanding, trading at $2.4 per share.

Based on the above financial data and using the cost of equity calculated, estimate the WACC of Blue Dot and based on the WACC above, what is the correct equity value per share?

Answer 1

To calculate the cost of equity we will make use of goal seek function of excel, where

40/(x)^1 + 45/(x)^2 + 50/(x)^3 + 520/(x)^4 = 410

It gives us a cost of equity of 14%

Number of shares outstanding = 410 million / 4.1 = 100 Million

Cash balance = $50 million

40% stake in JV = 40% of 25 miilion * (1.02)/ (13% - 2%) = 231.8 million * 40% = $92.72Million.

Debt market value = $120 Million

Equity market value = 2.4 * 100 million = 240 million

Debt /(Debt + equity) = 33.33%

Equity /(Debt + equity) = 66.67%

After tax cost of debt = cost of debt * (1-tax) = 5% * (1 - 0.25) = 3.75%

WACC = After tax cost of debt * Debt /(Debt + equity) + cost of equity *Equity /(Debt + equity)

= 3.75% * 0.33 + 14% * 0.67 = 1.2375% + 9.38% = 10.6175%

Correct value is given by

40/(10.6175%)^1 + 45/(10.6175%)^2 + 50/(10.6175%)^3 + 520/(10.6175%)^4 + cah - debt

This gives us a value of $3.87