You are a conservative investor who is considering investing in “Fly Away Films”, a small film company. You like the intrinsic valuation approach and want to calculate Fly Away Films’ weighted average cost of capital and then perform a discounted cash flow analysis. You note that the equity market risk premium is 5.8%. The risk free rate is 2.5% and the tax rate is 35%. You feel that Fly Away Films is riskier than the CAPM would indicate due to its small size and believe it has a size risk premium of 1.2%. You have the following information about Fly Away Films: • Bonds: Fly Away Films has two bonds as outlined below: - Bond One: six year maturity, $1,000 face value semi-annual coupon bond with a coupon of 1.73% and a yield to maturity of 4.23%. Fly Away Films has 25,637 of these bonds outstanding. - Bond Two: is a coupon bond that pays annually and has nine years to maturity. The coupon rate is 2.75%, its yield to maturity is 4.78% and its face value of $1,000. Fly Away Films has 7,864 of these bonds outstanding. • Equity: Fly Away Films has 4,125,876 common shares outstanding and its stock price is $3.56. Fly Away Films’ beta is 3.1 and its Shareholder’s Equity from the balance sheet is $9.3mm. • Unlevered Free Cash Flow as per the following table: LFY + 1 = $5,500,000 LFY + 2 = $6,250,000 LFY + 3 = $6,750,000 LFY + 4 = $7,298,000 LFY + 5 = $7,854,000 a) Calculate Fly Away Films’ weighted average cost of capital. Please show all your work. b) Perform a discounted cash flow analysis to determine what the intrinsic value of Fly Away Films is on a per share basis. Use the above 5 years of unlevered free cash flow projections and the perpetuity growth rate method to calculate the company’s terminal value. You believe Fly Away Films will grow into perpetuity at a 1.25% growth rate. You note that Fly Away Films has cash of $1,465,264. Please show all your work.
Cost of Capital
Shareholders and investors who invest into the capital of the firm desire to have a suitable return on their investment funding. The cost of capital reflects what shareholders expect. It is a discount rate for converting expected cash flow into present cash flow.
Capital Structure
Capital structure is the combination of debt and equity employed by an organization in order to take care of its operations. It is an important concept in corporate finance and is expressed in the form of a debt-equity ratio.
Weighted Average Cost of Capital
The Weighted Average Cost of Capital is a tool used for calculating the cost of capital for a firm wherein proportional weightage is assigned to each category of capital. It can also be defined as the average amount that a firm needs to pay its stakeholders and for its security to finance the assets. The most commonly used sources of capital include common stocks, bonds, long-term debts, etc. The increase in weighted average cost of capital is an indicator of a decrease in the valuation of a firm and an increase in its risk.
You are a conservative investor who is considering investing in “Fly Away Films”, a small film company. You like the intrinsic valuation approach and want to calculate Fly Away Films’ weighted average cost of capital and then perform a discounted cash flow analysis. You note that the equity market risk premium is 5.8%. The risk free rate is 2.5% and the tax rate is 35%. You feel that Fly Away Films is riskier than the
• Bonds: Fly Away Films has two bonds as outlined below:
- Bond One: six year maturity, $1,000 face value semi-annual coupon bond with a coupon of 1.73% and a yield to maturity of 4.23%. Fly Away Films has 25,637 of these bonds outstanding.
- Bond Two: is a coupon bond that pays annually and has nine years to maturity. The coupon rate is 2.75%, its yield to maturity is 4.78% and its face value of $1,000. Fly Away Films has 7,864 of these bonds outstanding.
• Equity: Fly Away Films has 4,125,876 common shares outstanding and its stock price is $3.56. Fly Away Films’ beta is 3.1 and its Shareholder’s Equity from the balance sheet is $9.3mm.
• Unlevered
LFY + 1 = $5,500,000
LFY + 2 = $6,250,000
LFY + 3 = $6,750,000
LFY + 4 = $7,298,000
LFY + 5 = $7,854,000
a) Calculate Fly Away Films’ weighted average cost of capital. Please show all your work.
b) Perform a discounted cash flow analysis to determine what the intrinsic value of Fly Away Films is on a per share basis. Use the above 5 years of unlevered free cash flow projections and the perpetuity growth rate method to calculate the company’s terminal value. You believe Fly Away Films will grow into perpetuity at a 1.25% growth rate. You note that Fly Away Films has cash of $1,465,264. Please show all your work.
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