Vulture Partners, a private equity organization specializing in distressed company investing, was interested in purchasing a company called Turnaround. Mr. Fang, a general partner at Vulture, made the following projections to value Turnaround ($mm):
Year 1 Year 2 Year 3 Year 4 Year 5
200 210 220 230 240
(100) (105) (110) (115) (120)
100 105 110 115 120
+3 +3 +4 +4 +5
Turnaround had $220 million of net operating losses (NOLs) that were available to offset future income. At the beginning of year 1, the company had $75 million of 8% debt (coupon & yield) which was expected to be repaid in three $25 million installments beginning at the end of year 1. The relevant tax rate is 40%. Mr. Fang believed that an appropriate unlevered beta for Turnaround was 0.8. The long-term treasury yield was 6.5 percent and the market risk premium 7.0%. Net cash flows were forecast to grow at 3 percent per year in perpetuity after year 5. Calculate the APV of Turnaround and do a sensitivity analysis on the perpetuity growth rate at 2 and 4 percent.
Also, will you use excel formulas in your solutions/answers or will provide everything calculated using non-excel formulas?
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1 Present value of tax shield is calculated @8% borrowing rate. It is assumed that
tax shields are just as risky as the interest payments generating them.
2. For first two years there will be no taxes and third year 15mn$ will have no taxes
as it will be set off against losses
3. Interest tax shield is calculated Interest* tax rate
CALCULATION OF COST OF CAPITAL
Ke = Rf+b(Km-Rf)
Ke= Cost of Equity capital
Rf= Risk free Rate 0.065
Km= Expected market return 0.135
b=beta coefficient 0.8
APV= BASE CASE ...
This explains the concept of long term investment decision making and also contains step by step demonstration of calculating NPV and APV of the project.