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Posted on Oct 03, 2024

Background: The WACC of 9.7%. - Determine all of the WACC inputs used to get to Snaps stated WACC. This includes breaking down the cost

Background:

The WACC of 9.7%.

- Determine all of the WACC inputs used to get to Snaps stated WACC. This includes breaking down the cost of equity into its separate components as well.

WACC = [2% * 3% (1-35%)] + [(100-2%) * 9.90%] = 9.74%

- Show the WACC formula with these input numbers.

WACC Formula = [Cost of Debt * % of Debt * (1- tax rate)] + [Cost of Equity * % of Equity]

- Calculate what beta Nowak used to estimate the cost of equity? Do you think this beta is reasonable? Discuss why or why not.

E(r_i) = r_f +B_i [r_m - r_f]

Estimated Required Return E(r_i) = 9.90% - given in the Morgan Stanley Valuation Assumptions

Risk Free Rate (r_f) = 2.38% - US Treasury for 10-years of March 2017

Risk Premium [r_m - r_f] = 5.59% - given in the Morgan Stanley Valuation Assumptions

Beta:

B_i = [E(r_i) - r_f]/ [r_m - r_f]

= [(9.90% - 2.38%] / 5.59%

= 1.34

Beta measures the stability and reaction of a particular stock compared to the whole market. We also need to point out that for betas greater than 1, they would be riskier and more sensitive as they either go up or down more than the market. They would have higher required return but that also comes with the highest risk; reasons for this could be the firms investments, operations, stability etc.

- How does this WACC compare to the WACCs Nowak has used to value other internet and social media companies? (Show a table as well as discuss)

Company	Beta	Risk Free Rate	Market Return	CAPM
Snap	1.34	2.38	5.59	2.38 + 1.34 * [5.59] = 9.90%
Twitter	0.80	2.38	5.59	2.38 + 0.80 * [5.59] = 6.85%
Facebook	0.87	2.38	5.59	2.38 + 0.87 * [5.59] = 7.24%

The information founded is not surprising as Twitter and Facebook have been in the industry longer than Snapchat and yet more stable in terms of risk and return. Beta here shows the stability and reaction of a particular stock compared to the whole market. As mentioned above, these numbers could reflect the firms investments, operations, stability etc.

- Are these the best list of comparable firms to consider? Discuss.

- How does this WACC compare to the WACCs that other analysts have used to value Snap? (Show a table as well as discuss)

- In your opinion, is 9.7% reasonable? Discuss why.

b. The terminal value growth rate of 3.5%. (15 points)

- Did Nowak calculate the terminal value using a growth perpetuity of FCF or did he use multiples of FCF?

- How does 3.5% compare to what other analysts assumed? (Show a table as well as discuss)

- In your opinion, is 3.5% reasonable? Discuss why.

- What is the terminal value (in year 2025 dollars)? (Hint: The terminal value that he uses is not shown in the table. He is just showing you the forecasted FCF in year 2026 that is used in the TV formula.)

c. The free cash flow forecast in general and Snaps 2020 revenue forecast in particular. (15 points)

- What growth rates does the FCF forecast assume for revenue? (Hint: not terminal value but the first years of FCF)

- Discuss how Nowaks report argues that Snap will accomplish this growth.

- In your opinion, is this growth rate reasonable? Discuss why.

- How does the revenue forecast compare against what other analysts have predicted?

- Did the analysts with more optimistic FCF forecasts use higher or lower discount rates? (Show a table as well as discuss)

- Does this explain why the price target estimates by the different analysts was fairly close even though they had very different FCF forecasts? Explain.

Question:

What would happen if you lowered all FCF forecast numbers by 10% (but leaving the WACC at 9.7%)? Show all of the steps in question 2 again but with the new change incorporated. By how much did the share price change? Why did the price go up or down? Discuss your analysis.