 # AirThread Harvard Case Solution & Analysis

Describe the approach that should be used to value Air Thread – WACC, APV, other or some combination? How should cash flows for 2008-2012 be valued?  How should the terminal value or going concern be estimated?  How should non-operating investments in equity affiliates be accounted for in the valuation?  (It may be possible to use more than one technique simultaneously.

Different Approaches of Cash flow Valuation:

The different valuation techniques can be used for calculation of the cash value. The two different techniques are used for cash valuation for Airthread that are the present value technique and adjusted present value technique. Cash flow is calculated by adding all the non cashflow expenses, that are depreciation and amortization and taking into consideration the net changes in working capital and net changes in capital expenditure. The calculated cash flow is valid with an assumption that the cost of capital is 8.01 percent and the cost of debt is assumed to be 5.5%.

Please refer to the attached excel file with sheet named as RATE for calculation of WACC.

Terminal value analysis on going concern.

Terminal value is the future expected cash flow of the company, if the company is on going concern basis. The terminal value of the Airthreadalso calculated on the basis that the company is following the going concern basis. Terminal valueis calculated by using the net projected future cash flows of the Airthread business. Terminal value is calculated by discounting the projected cash flow of the 2012 with a cost of capital of the Airthread which is 8.01 percent. Then, the present value of the terminal value is calculated by discounting the terminal value with discount rate to calculate the today value of Airthread.

The different valuation methods for evaluation are price earnings ratio, market multiples, net present value and adjusted present value. All these methods are used to calculate the enterprise value.

QUESTION # 01:What discount rate should Ms. Zhang use for un-levered FCF for 2008-2012?  Is this the same discount rate that should be used to value the terminal value? Why or why not?

Discounted rate For Unlevered FCF.

Zhang should select an appropriate discount rate for the valuation of the future cash flow of the Airthread according to the capital structure of the project. Weighted average cost of capital is the better discount rate for valuation of the Airthread, which is 8.01 percent. Weighted average cost of capital is calculated for mix capital structure debts and as well as equity. Ungeared free cash flows should discount by the cost of equity and terminal value is also calculated by using the cost of equity as ungeared free cash flow is solely related to equity financing. Weighted average cost is the capital and the better option for discounting the cash flow of the Airthread.

QUESTION # 02: What is the long term growth rate that should be used to estimate Air Thread’s terminal value? Using your estimate of the long term growth, what is the present value of the Air Thread going concern value?

Growth rate of terminal value

The growth rate forthe terminal valueof Airthread is calculated by using the growth model, that is multiplying the return on capital employed with the retention ratio of the future expected investment.The retention ratio as calculated in the attached excel file is 20.6 percent and the return on capital employed is 16.6 percent. Multiplication of this return on capital employed with the retention ratio equals the growth rate, which is 3.42% for 2012.

Please refer to the attached excel file with sheet named as RATE GROWTH for calculation of return on capital employed and retention ratio.

Using the assumption of long growth and Airthread as a going concern business. Value of Airthread is \$5,601 without considering any effect of synergy, this value of Airthreadrepresents the present value of the cash flows and  present value of terminal cash flow.  Adjusted present value also calculated to show the more appropriate present value of the Airthread by considering the tax shield on the  interest payment. The adjusted present value of Air Thread is \$5,886.

Please refer to the attached excel file with sheet named as PRESENT VALUE & APV NO SYNERGY  for calculation of present value and adjusted present value.

QUESTION # 03:What is the total value of Air Thread before considering any synergies?  What is the value assuming Ms. Zhang’s estimates for synergies are correct?  Should the value of the tax benefits reflect the personal tax advantage of interest income to ordinary debt holders?  If so, what is the personal income tax advantage of the debt?

Value of Airthread business without considering any effect of synergies, business value is \$5,601, which is calculated by adding the present value of terminal cash flow and present value of the projected cash flows. APV......................

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