Virgin is entering in the airline business. Virgin is expecting to finance this new activity both with

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Question:

Virgin is entering in the airline business. Virgin is expecting to finance this new activity
both with debt and equity, and your task is to compute the appropriate cost of capital and
make a project evaluation. You realize that using the beta for airlines industry would also
include routes where Virgin would not be directly involved. As a matter of fact Virgin is
interested in flying only across the Atlantic for the time being and therefore it will
consider only the equity beta for three major would be competitors. Information about the
competitors is reported below:

Company Stock Price Number of Shares

US Airways 48 3,000,000

Continental 40 3,550,000

American Airlines 52 2,750,000

Company β-Equity
US Airways 1.2
Continental 1.3
American Airlines 1.25

Compute the total market value for each company. Hint: market value is equal to:

Market value = (stock price) (number of shares)
2. Compute the average un-levered beta for the airline business. Assuming a corporate tax rate equal to 30% and for each company.
3. Compute the re-levered beta for Virgin Atlantic assuming the following capital structure: and also, a corporate tax rate equal to 30%
and.
4. Using the following assumption perform a project evaluation using both the WACC,APV and FTE method and assuming that the project delivers the cash flows forever.Hence it is perpetuity. Values are in Millions of GBP.

Company Stock Price Number of Shares
US Airways 48 3,000,000
Continental 40 3,550,000
American Airlines 52 2,750,000
Company Debt
US Airways 90,000,000
Continental 85,000,000
American Airlines 95,000,000
Companyβ-Equity
US Airways 1.2
Continental 1.3
American Airlines 1.25
0Db=
(/)0.4DV= (/)0.6EV=
0Db=
Assumptions
E BIT 250 Corporate Tax rate 30%
Equity (millions) 600 Depreciation 0
Debt (millions) 400 Capex 1,000
Cost of Debt 6% Δ Working Capital 0
Risk Free R ate 5.0% D/V (d) 0.4
Equity Premium 8.4% E /V 0.6

Note that that the project Capex of 1,000 is financed with 60% equity and 40% debt.
Hints:
Recall that WACC, APV and FTE method must deliver the same outcome. Start with WACC method and then work out the remaining two.
The cost of capital in the case of perpetuity is computed as:

Un-levered Cash Flow is used for the WACC and APV method, while the Levered Cash Flow is used for FTE method. When building the Levered and Un-levered cash flows do not include the capex as they are assumed to occur at period 0 and the first cash flow occur at period one. To compute the Debt Rebalancing you must use the initial level of debt of Virgin Atlantic. Refer to the handout on the company and project evaluation for further hints and tips.