Apache Airlines, a privately held firm, is looking to buy additional gates at its home airport for $500,000. Apache has $240,000 in the bank but that money may not be spent as it is used to pay salaries, suppliers, and equipment. Apache asked its bank for a loan but the bank refused saying that Apache's interest-bearing debt to equity was too high at 3.1. The bank said that Apache needed to lower that ratio below 2.5 in order to get the loan. Separately, SkyBlue Airlines has approached Apache to see if Apache will buy it.
Apache's CFO hired you to help with financial analyses. To help, the CFO tells you the following:
- Apache's cost of capital is ~7.7%. This is based on two airlines trading in the capital markets- Caledonian and Laker. Since Apache does not trade, it has no beta, so the CFO used Caledonian and Laker as proxies
- Aside from the purchase price, the gates will require a working capital infusion at purchase of $200,000. Apache estimates the gates will generate cash flows of $280,000/year for the next 8 years. After that, the gates will revert back to the airport operator. You must calculate the NPV and IRR of the gates
- you were given SkyBlue's 2018 income statement (IS) and balance sheet (BS), along with forecasts of the revenue growth and tax rates. You must forecast the IS and BS for the next 3 years
- The price discussed by the two CEOs is 44x SkyBlue's 2018 net earnings. You must calculate this price and compare it with the free cash flow value of SkyBlue, which you must also calculate. The CFO wants to know if Apache is overpaying or underpaying for SkyBlue
- Apache's forecast balance sheet has been included in the Excel file, so you need do nothing to it. However, the CFO has asked you to consolidate the two balance sheets - the Apache one given to you and the SkyBlue one that you calculated. Once these two are consolidated, you are asked to calculate three debt ratios, as listed in the file
- Finally, the CFO wants to know if the consolidated balance sheet's Debt/Equity ratio is below 2.5. if so, it will allow Apache to buy the gates. Is Apache's ratio low enough that they can borrow to buy the gates?
B C D E F G H I J K L M N O 1 This case has the following road map: 2 Tab 3 WACC Shows the financials for both airlines and calculated the weighed average cost of capital (WACC) for the combined airline 4 Machine NPV Please calculate the NPV of the new gates 5 SkyBlue financials Calculate SkyBlue's income statement (IS) and balance sheet (BS) in order to run free cash flows in the valuation tab 6 SkyBlue valuation Calculate the present value of SkyBlue using free cash flows 7 Apache BS (balance she Shows Apache's balance sheet for 2018 and forecast 2019-2021 8 Consolidated BS Consolidates Apache's and SkyBlue's balance sheets and recalculates the bank ratios 10 Please note: All figures are in thousand $ unless noted otherwise K B C D E F G H I J Start Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Investment Working Capital Operating Cash Flow Total Cash Flow - NPV - IRR Read 1st! WACC Machine NPV SkyBlue financials | SkyBlue valuation Apache BS Consolidated BS mt Component 1 Net Income (M$) 2 Earnings per share 3 # of shares (M) 4 Price per share 5 Market Value - Equity (M) 6 Market Value - Debt (M) 7 Market Value - Total (M) 8 -% Debt 9 -% Equity 10 Beta (levered) 11 Beta (unlevered) 12 Average Beta (unlevered) C Caledonian 33.40 1.04 32.12 14.00 450 341 791 D Laker Source 24.10 Given 1.53 Given 15.75 Net Income / Earnings per share 12.63 Given 199 # of shares x Price per share 75 Given 274 Market Value - Debt + Equity 27% Market Value - Debt / Market Value - Total 73% 1-% Debt 0.93 Given 0.68 Beta (levered) x % Equity 0.64 Average 43% 57% 1.07 0.61 Values for combined Apache/SkyBlue airlie: % Debt 45.0% % Equity 55.0% Beta (relevered) 1.16 Risk free rate 4.0% Market risk premium 5.5% Expected equity return 10.4% Expected cost of debt 5.5% Tax rate 21.0% WACC 7.7% Given 1 -% Debt Average Beta (unlevered) / % Equity Assumption Historical figure CAPM calculation Given Statutory rate Sum of weightings Read 1st! WACC Machine NPV SkyBlue financials SkyBlue valuation Apache BS Consolidated BS 375 Actual Projected 2 Income Statement 2018 2019 2020 2021 Notes 3 Key Assumptions: Average growth rate: 0% 6% 6% 5 Tax Rate 21% 21% 21% 21%. Use current statutory rate of 21% 6 Net Sales 5.000 Increase using the average growth rate 7 - Cost of Goods Sold (C 3.075 Use same percent of Net Sales as in 2018 * = Gross Profit 1,925 Calculation 9 - SG & A Expenses 1550 Use same percent of Net Sales as in 2018 10 . EBIT Calculation (Use for Free Cash Flow valuation!) 1 - Interest 100 Hold at 2017 level Calculation 13 - Taxes Use implicit rate of 2018 14 - Net Income Calculation 5 Balance Sheet 76 Cash 17 Notes and Acc. Rec. 1,000 48 Inventory 800 Increase at average growth rate 119 Prepaid 20 Current Assets 1,950 21 Other 1250 Leave flat 22 Total Assets See below Increase at average growth rate Leave flat Leave flat 24 Bank Loan 25 Payables 26 CPLTD 27 Other 28 Current Liabilities 29 LTD 30 Equity 31 Total Liabilities & E 375 500 2.250 3.125 LTD of previous year minus CPLTD of current year Equity of previous year plus net income of current year 33 Vorking Capital 1,825 Exclude Bank Loan is Note: the Bank Loan is a plug figure. Its formula starts with total assets and subtracts the liability and equity accounts. If the Bank Loan nurnber is positive, it is debt. If negative, it is basically cash. Read 1st! WACC Machine NPV SkyBlue financials SkyBlue valuation Apache BS Consolidated BS B C D SkyBlue Acquisition 2 - Earnings Multiple 3 - 2018 actual net earnings Price 5 Value based on free cash flows: Price Paid 2019 2020 7 EBIT 8 EBIAT 9 - Change in Working Capital 10 - Change in PP&E 11 Free Cash Flow 12 Terminal Value 13 Present Value 14 PV of Free Cash Flows 15 - Existing Debt 16 = Present Value of SkyBlue 17 18 (Underpay)/Overpay for SkyBlue 2021 Notes From Pro Formas - EBIT projection EBIT minus tax From Pro Formas (exclude Bank note plug!) From Pro Formas Calculation Assumes growth rate given Calculation Calculation Bank Loan + CPLT +LTD Calculated value If negative, Apache Airlines paid less than SkyBlue is worth Read 1st! WACC Machine NPV SkyBlue financials SkyBlue valuation Apache BS Consolidated BS 2 Balance Sheet 3 Cash 4 Notes and Acc. Rec. 5 Inventory 6 Prepaid 7 Current Assets 8 Other 9 Total Assets Actual 2018 240 7,013 5,588 192 13.033 3,325 16,358 Projected 2019 2020 250 250 8,385 9,998 6,630 7,905 195 232 15,460 18,385 3,830 4,393 19,290 22,778 2021 Notes 250 12,040 9.520 280 22.090 5,105 27,195 11 Bank Loan 12 Payables 13 CPLTD 14 Other 5 Current Liabilities 6 LTD 6,070 3,057 433 1,477 11,037 2,458 7,586 3,705 450 1,712 13,453 2,008 9,321 4,417 450 1,994 16.182 1,558 11,404 5,320 450 2,350 19,524 1,108 18 Equity 19 Total Liabilities & Equity 2,863 16,358 3,829 19,290 5,038 22,778 6,563 27,195 !1 Ratios: 2 Bank Loan to Receivables 3 Liabilities / Equity 14 Debt / Equity 0.9 4.7 3.1 0.9 4.0 2.6 0.9 3.5 22 0.9 3.1 2.0 Read 1st! WACC Machine NPV SkyBlue financials SkyBlue valuation Apache BS Consolidated BS M Actual 2018 Projected 2019 2020 2021 1 2 Balance Sheet 3 Cash 4 Notes and Acc. Rec. 5 Inventory 6 Prepaid 7 Current Assets s Other 9 Total Assets 10 11 Bank Loan 12 Payables 13 CPLTD 14 Other 15 Current Liabilities 16 LTD 17 Equity 18 Total Liabilities & Equity 19 20 Ratios: 21 Bank Loan to Receivables 22 Liabilities / Equity Debt / Equity Read 1st! WACC Machine NPV SkyBlue financials SkyBlue valuation Apache BS Consolidated BS B C D E F G H I J K L M N O 1 This case has the following road map: 2 Tab 3 WACC Shows the financials for both airlines and calculated the weighed average cost of capital (WACC) for the combined airline 4 Machine NPV Please calculate the NPV of the new gates 5 SkyBlue financials Calculate SkyBlue's income statement (IS) and balance sheet (BS) in order to run free cash flows in the valuation tab 6 SkyBlue valuation Calculate the present value of SkyBlue using free cash flows 7 Apache BS (balance she Shows Apache's balance sheet for 2018 and forecast 2019-2021 8 Consolidated BS Consolidates Apache's and SkyBlue's balance sheets and recalculates the bank ratios 10 Please note: All figures are in thousand $ unless noted otherwise K B C D E F G H I J Start Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Investment Working Capital Operating Cash Flow Total Cash Flow - NPV - IRR Read 1st! WACC Machine NPV SkyBlue financials | SkyBlue valuation Apache BS Consolidated BS mt Component 1 Net Income (M$) 2 Earnings per share 3 # of shares (M) 4 Price per share 5 Market Value - Equity (M) 6 Market Value - Debt (M) 7 Market Value - Total (M) 8 -% Debt 9 -% Equity 10 Beta (levered) 11 Beta (unlevered) 12 Average Beta (unlevered) C Caledonian 33.40 1.04 32.12 14.00 450 341 791 D Laker Source 24.10 Given 1.53 Given 15.75 Net Income / Earnings per share 12.63 Given 199 # of shares x Price per share 75 Given 274 Market Value - Debt + Equity 27% Market Value - Debt / Market Value - Total 73% 1-% Debt 0.93 Given 0.68 Beta (levered) x % Equity 0.64 Average 43% 57% 1.07 0.61 Values for combined Apache/SkyBlue airlie: % Debt 45.0% % Equity 55.0% Beta (relevered) 1.16 Risk free rate 4.0% Market risk premium 5.5% Expected equity return 10.4% Expected cost of debt 5.5% Tax rate 21.0% WACC 7.7% Given 1 -% Debt Average Beta (unlevered) / % Equity Assumption Historical figure CAPM calculation Given Statutory rate Sum of weightings Read 1st! WACC Machine NPV SkyBlue financials SkyBlue valuation Apache BS Consolidated BS 375 Actual Projected 2 Income Statement 2018 2019 2020 2021 Notes 3 Key Assumptions: Average growth rate: 0% 6% 6% 5 Tax Rate 21% 21% 21% 21%. Use current statutory rate of 21% 6 Net Sales 5.000 Increase using the average growth rate 7 - Cost of Goods Sold (C 3.075 Use same percent of Net Sales as in 2018 * = Gross Profit 1,925 Calculation 9 - SG & A Expenses 1550 Use same percent of Net Sales as in 2018 10 . EBIT Calculation (Use for Free Cash Flow valuation!) 1 - Interest 100 Hold at 2017 level Calculation 13 - Taxes Use implicit rate of 2018 14 - Net Income Calculation 5 Balance Sheet 76 Cash 17 Notes and Acc. Rec. 1,000 48 Inventory 800 Increase at average growth rate 119 Prepaid 20 Current Assets 1,950 21 Other 1250 Leave flat 22 Total Assets See below Increase at average growth rate Leave flat Leave flat 24 Bank Loan 25 Payables 26 CPLTD 27 Other 28 Current Liabilities 29 LTD 30 Equity 31 Total Liabilities & E 375 500 2.250 3.125 LTD of previous year minus CPLTD of current year Equity of previous year plus net income of current year 33 Vorking Capital 1,825 Exclude Bank Loan is Note: the Bank Loan is a plug figure. Its formula starts with total assets and subtracts the liability and equity accounts. If the Bank Loan nurnber is positive, it is debt. If negative, it is basically cash. Read 1st! WACC Machine NPV SkyBlue financials SkyBlue valuation Apache BS Consolidated BS B C D SkyBlue Acquisition 2 - Earnings Multiple 3 - 2018 actual net earnings Price 5 Value based on free cash flows: Price Paid 2019 2020 7 EBIT 8 EBIAT 9 - Change in Working Capital 10 - Change in PP&E 11 Free Cash Flow 12 Terminal Value 13 Present Value 14 PV of Free Cash Flows 15 - Existing Debt 16 = Present Value of SkyBlue 17 18 (Underpay)/Overpay for SkyBlue 2021 Notes From Pro Formas - EBIT projection EBIT minus tax From Pro Formas (exclude Bank note plug!) From Pro Formas Calculation Assumes growth rate given Calculation Calculation Bank Loan + CPLT +LTD Calculated value If negative, Apache Airlines paid less than SkyBlue is worth Read 1st! WACC Machine NPV SkyBlue financials SkyBlue valuation Apache BS Consolidated BS 2 Balance Sheet 3 Cash 4 Notes and Acc. Rec. 5 Inventory 6 Prepaid 7 Current Assets 8 Other 9 Total Assets Actual 2018 240 7,013 5,588 192 13.033 3,325 16,358 Projected 2019 2020 250 250 8,385 9,998 6,630 7,905 195 232 15,460 18,385 3,830 4,393 19,290 22,778 2021 Notes 250 12,040 9.520 280 22.090 5,105 27,195 11 Bank Loan 12 Payables 13 CPLTD 14 Other 5 Current Liabilities 6 LTD 6,070 3,057 433 1,477 11,037 2,458 7,586 3,705 450 1,712 13,453 2,008 9,321 4,417 450 1,994 16.182 1,558 11,404 5,320 450 2,350 19,524 1,108 18 Equity 19 Total Liabilities & Equity 2,863 16,358 3,829 19,290 5,038 22,778 6,563 27,195 !1 Ratios: 2 Bank Loan to Receivables 3 Liabilities / Equity 14 Debt / Equity 0.9 4.7 3.1 0.9 4.0 2.6 0.9 3.5 22 0.9 3.1 2.0 Read 1st! WACC Machine NPV SkyBlue financials SkyBlue valuation Apache BS Consolidated BS M Actual 2018 Projected 2019 2020 2021 1 2 Balance Sheet 3 Cash 4 Notes and Acc. Rec. 5 Inventory 6 Prepaid 7 Current Assets s Other 9 Total Assets 10 11 Bank Loan 12 Payables 13 CPLTD 14 Other 15 Current Liabilities 16 LTD 17 Equity 18 Total Liabilities & Equity 19 20 Ratios: 21 Bank Loan to Receivables 22 Liabilities / Equity Debt / Equity Read 1st! WACC Machine NPV SkyBlue financials SkyBlue valuation Apache BS Consolidated BS
