Astral Records Ltd., North America: Some Financial Concerns Harvard Case Solution & Analysis

Astral Records Ltd., North America: Some Financial Concerns Case Solution

Calculation of WACC

In order to identify total value of the enterprise, there is a need to identify appropriate discount rate. The WACC for Astral is calculated with the help of capital asset pricing model. With the help of capital asset pricing model, cost of equity is identified and by using this cost of equity, the cost of capital of the company is calculated.

There are certain assumptions that have been taken while calculating cost of equity through capital asset pricing model. It is expected that Beta of comparable industries is used in this formula. By taking the average beta of comparable industries and then incorporating the capital structure of the company, equity beta is identified.

Risk free debt and risk premium for the company are identified by taking certain assumptions like by using 30 years treasury rate risk free debt is identified and by using Libor and three months treasury rate market risk premium is calculated. By using equity beta, risk free rate and market risk premium, the cost of equity is identified which is 20.3%.

By using the interest expense of last four years the cost of debt is assumed , then putting the values of cost of debt, value of debt , cost of equity and value of equity into the formula of WACC, the cost of capital is calculated which is 11.6%. The value of debt and of equity is identified with the help of ratios and using the average growth rate over the value of debt, the current value of debt is identified.

Enterprise value and value of the firm

By using the discount rate that is calculated with the help of capital asset, the pricing model value of equity is identified. By discounting the free cash flows at a discount rate of 11.6%, the net present value of the company is identified.

It is expected that the company is generating positive net present value of worth $343390. In order to identify the equity part in this net present value, the net interest bearing debt is deducted from this value. It is expected that net interest bearing debt of the company is 50853 dollars. By deducting this value through the net present value, the value of equity for the company is identified which is 292537 dollars.

Therefore, there is a significant potential of growth in the company with respect to future earnings and it is expected that future cash flows are greater than the total debt of the company, which shows that in next five years the company could resolve the current facing problems through better and efficient management.

Sensitivity analysis

It is expected that the valuation of the company is performed by taking certain assumptions, such as it is assumed that company’s sales will grow by 15% in projected years and it is also expected that the company’s earnings will grow by 4% after these five foretasted years for the foreseeable future. Therefore, there is a risk that the growth of 15% is assumed for the projected years and growth of 4% in perpetuity do not seem to be reasonable assumptions as the past performance of the company was not well.

In addition to this, it is also expected that WACC will also remain same over the life of the company, which is also not a realistic assumption as WACC changes over the period which means that if WACC increases over the time, then it could reduce the value of the company.

Analysis of Proposed Investment

Although the current equipment of the company is enough in order to meet the current demands of the company,it is expected that in near future demands of the compact disks will increase significantly and after three years the company would have to buy new and advanced machinery. Moreover, the current machinery is incurring high maintenance cost and labor cost and as a result it slows the production processes.........................

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