Discuss AirThread's capital structure and make appropriate assumptions. Based on your capital structure assumption, which absolute valuation model would you choose to value AirThread? Justify your choice

Capital Structure & Illiquidity Discount:

Jennifer decided to use Bianco's recommendation of a 5% equity market risk premium, an EBITDA interest coverage ratio of 5.0x based on 2007 operating results, and/or a debt to value ratio not exceeding 50.0% when calculating the initial leverage for AirThread. However, she also wanted her preliminary valuation to conform to American Cable's established practice of paying down acquisition debt to eventually reflect industry norms. As a result, she assumed the acquisition debt would consist of a single tranche amortizing monthly over 10 years, but with a bullet payment4at the end of year 5 (seeExhibit 6). The bullet payment would be in an amount necessary to bring AirThread's leverage ratios in line with those of the industry.

Based on the information provided by Rubinstein & Ross, Jennifer estimated that the debt rating was likely to be investment grade with a rating of BBB+ and have an interest rate of approximately 5.50%, which reflected a 125bp spread over the current yield on 10-year US Treasury bonds.

In order to estimate AirThread's beta, Ms. Zhang decided to use the comparable company information contained inExhibit 7. However, the more troubling issue was how to handle the potential discount, if any, resulting from AirThread's status as a private company. In contemplating this issue Jennifer believed that it may be necessary to follow the customary practice of employing a private company discount. This discount is primarily related to the illiquidity of private investments, but also considers certain types of agency costs as well as the financial health and size of the firm. Most of the academic research of which Ms. Zhang was aware estimated the illiquidity discount to be in the range of 35%, though rules of thumb often employed by practitioners put the range in the area of 20% to 30%.5Exhibit 8provides a graphical depiction of the relationship between revenue and the illiquidity discount for profitable and unprofitable firms.

On the other hand, there was also a well-established school of thought that believed large profitable firms with the ability to go public should not trade at a discount due to their status as private companies. The reasoning is based on the notion that owners wouldn't accept an illiquidity discount because they have the public market option.