"You have read the Wilson Aviation case. Now, please answer questions in the case using the Excel templatebelow. The template already contains all the data you need to complete your work."
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WACC ComponentMaxwellBarstonNotes Net Income (M$)17.229.70 Earnings per share (EPS)4.204.50 # of shares (M)Net Income / EPS Price per share14.0011.50 Market Value - Equity (M)# of shares x price per share Market Value - Debt (M)207 Market Value - Total (M)7732 - % DebtDebt as a per cent of Total MV - % EquityEquity as a per cent of Total MV Beta (levered)0.600.66as reported in Value Line Beta (unlevered)Beta (levered) x % Equity Average Beta (unlevered)Average of the two Beta (unlevered) Values for Wilson: % Debt25.0% % Equity Beta (relevered) alfonso canella: alfonso canella: Average Beta (unlevered) / % EquityRisk free rate2.0% Market risk premium6.0% Expected equity return (CAPM) Expected cost of debt4.9% Tax rate21.0% Weighed average cost of capital (WACC) Inc Statement and Bal Sheet ActualProjected Income Statement (in '000 $)202020212022202320242025Notes Growth rates: Parts Sales5.0%5.0%5.0%5.0%5.0% Service Program6.0%6.5%6.5%6.5%6.5% Parts Sales 2,223 Service Program2,142 Total Operating Revenues4,365 Salaries and benefits995Increase at a yearly rate of4.5% Research and development9227.0% Service expense5655.0% Sales and Administrative4374.0% Depreciation/amortization3744.0% Total Operating Expenses3,293 Income before taxes1,072 Income tax expense/(benefit)225 Net Income847 Balance Sheet Cash and investments1,934Increase at a yearly rate of12.0% Accounts receivable1,24910.0% Inventory and supplies, net1,0459.0% Other1923.0% Current Assets4,420 Other5,932Increase at5.0% Total Assets10,352 Bank Loan4,049Plug account Payables248Increase at a yearly rate of5.0% CPLTD441.0% Other933.0% Current Liabilities4,434 LTD1,877 Equity4,041 Total Liabilities & Equity10,352 Working Capital4,035Exclude Bank Loan FCF valuation Free Cash Flow Valuation (in '000 $)20212022202320242025TV Income before taxes + Interest = Income before interest and taxes (EBIT) EBIAT - Change in Working Capital - Change in Other assetsGrowth rate Free Cash Flow (FCF)2.5% PV of FCF = EV - Existing Debt = Value of equity v. MAR 22 No content - Intentionally left blank Wilson Aviation: Valuing a Business Alfonso F. Canella Higuera October 18, 2021 Daniel Rouse was a fixture at the Deerfield Airport in central California. Daniel, now 50 years old, had started working there when he was in high school, continued working there through college at Cal Poly in San Luis Obispo, and continued using the airport, flying his Cessna there during visits from southern California, where he was working as an engineer for Boeing. Daniel had just taken an early retirement package and decided to go home. So, one day, he flew his Cessna back, tied it down, and never looked back at southern California again. He renovated his parents’ home, some two miles from Deerfield Airport, and stayed there for good. He loved the area, the weather, the scenery, the laid-back atmosphere, and, yes, the access to the airport. Oh, and everyone knew Daniel and appreciated him! The weeks passed after his arrival and Daniel grew restless. He had worked long and hard at Boeing and it was difficult to change gears. He wanted something to do and was wondering what it would be. That evening, while hanging out at the airport’s restaurant, he was offered the purchase a business that sold aircraft controls to Boeing. Daniel could only remark “the apple doesn’t fall far from the tree, does it?” The firm’s owner, Harlan Wilson, 78, had known Daniel for decades and loved him like a son. Seeing that Daniel had moved to the area for good, Harlan, also a Cal Poly alum, had 5 children but they were not interested in engineering or flying or moving to Central California or running a business. And since his 12 grandchildren were his heirs, he had to sell the firm to help fund their college educations. So, it made sense to see if Daniel, whom Harlan trusted implicitly, would continue the business and keep it locally owned. Daniel’s engineering experience at Boeing certainly helped smooth the transition to a new owner. And so it was. Daniel was very receptive and Harlan offered to give him the firm’s financials so Daniel could figure out a purchase price. Harlan had a notion of the price of his firm (an even million) but he hadn’t run the numbers. He wouldn’t run them anyway; Harlan knew that Daniel’s honesty was as long as a summer day and he knew they’d work out a fair price without bringing in an appraiser. Harlan knew Daniel might not have the money required to buy the business outright. He understood, rightly, that a lot of Daniel’s net worth was tied up in retirement accounts that would trigger a large tax bill if they were cashed out. So, Harlan threw in a sweetener: “I’ll keep 50% of the equity in the business and you can pay me 5% on it for the first 5 years. At the end of those 5 years, buy me out for what we calculate the 50% is worth today.” The proposal was clever – Harlan would earn a sure 5% on his money, which was clearly higher than he could expect on his Treasury investments. Also, with the extra equity, Daniel could borrow at a lower rate from the bank as the firm would have little debt. It was a win-win. Daniel accepted and they wrote the terms of the agreement on the restaurant’s paper table covering. After signing on the terms, Daniel and Harlan walked over to Wilson Aviation’s offices so that Harlan could give him the financials. Page 2 of 7 The next day, Daniel sat down and started going through Wilson Aviation’s financials. These financials would help him generate the free cash flow projections (FCF) that he could then present value to get the enterprise value (EV) of Wilson Aviation. To remind himself of the entire process, he wrote on the dry erase board in his office what he needed to do: 1. Calculate the weighed average cost of capital (WACC): a. Estimate the appropriate cost of debt and the amount of debt for Wilson after the purchase and the tax rate to be applied b. Estimate the cost of equity for a firm like Wilson Aviation; this would require using the Capital Asset Pricing Model (CAPM) c. To use the CAPM, Daniel would need to estimate Wilson’s beta (ß), which is the firm’s covariance of returns relative to the overall stock market. Daniel would also need the 10-year Treasury rate as a stand in for the risk-free rate and the stock market’s historical returns over and above the risk-free rate (this was called the market premium) 2. Forecast the firm’s income statement for the next 5 years 3. Use the results from the income statement to forecast the firm’s balance sheet and use the numbers generated to calculate the working capital for each year 4. Generate the FCF as follows: a. Get the Income Before Taxes from the income statement b. Add to these the interest paid by adding the Bank Loan, Current Portion of Long Term Debt (CPLTD), and Long Term Debt (LTD) together and multiplying that by the debt interest rate used in the WACC calculation c. The sum of Income Before Taxes and the interest paid is now equal to Earnings Before Interest and Taxes (EBIT) d. Subtract the actual taxes paid from EBIT to get Earnings before Interest and After Tax (EBIAT) e. Subtract the increases from year to year of Working Capital from EBIAT f. Subtract the increases from year to year of Other Assets from EBIAT (this is a proxy of capital expenditures) g. Once the two subtractions are done, you are left with the FCF h. Use the perpetuity formula to calculate the terminal value (TV); in this case, apply a long term growth rate of 2.5% as a higher growth rate was not appropriate and would also high too high an EV i. Use the NPV function of Excel with the WACC as the discount rate to get the present value of the FCF j. Subtract the 2020 values for Bank Loan, CPLTD, and LTD to get the dollar value of equity Daniel started from the top by commencing to calculate Wilson Aviation’s WACC. Because Wilson was privately owned by Harlan, it had no stock price data. So, Daniel would have to start from scratch. The formula for the WACC is: [% Debt x Cost of Debt x (1 – tax rate)] + [% Equity x Cost of Equity] Page 3 of 7 Daniel had done some research since his retirement and had some notions of what would work: % Debt = 25% Cost of debt = 4.9% Tax rate = 21% % Equity = 75% (basically, it was 1 - % Debt) Cost of Equity = ??? He needed to come up with a way to calculate the cost of equity for Wilson. Since it wasn’t traded, he had no beta (ß) to plug into the Capital Asset Pricing Model (CAPM) that allows analysts to come up with an expected return on equity: Cost of Equity = Risk-Free Rate + [Beta x Market Premium] He had checked out the internet and found out the following: Risk-Free Rate = 2.0% (10-year Treasury) Market Premium = 6.0% (a historical average that varied based on what years were averaged) Beta = ??? Daniel needed to get a beta but how? He emailed his old professor at Cal Poly as he suspected that he might know. The professor replied that Wilson Aviation had two major competitors in its industry, Maxwell and Barston, and they had public data that could be used to back into the industry’s average beta. He gave the data to Daniel, who then put together the table below: The unlevered beta was the risk associated with the industry. Daniel needed to take that unlevered beta and relever it to make it specific to Wilson Aviation. To do this, he put together another table: Component Maxwell Barston Notes Net Income (M$) 17.22 9.70