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Valuation of British Telecom 1984. Methodology We used the DCF method to
value BT. This is based on the fact that BT is a relatively ...
Submitted by ok9000 on March 24, 2008
Category: Business
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Methodology
We used the DCF method to value BT. This is based on the fact that BT is a relatively stable business with cash flows that can be forecast and a terminal value that can be easily calculated. We did not find the use of comparables a valid choice as these numbers could be grossly misleading due to differences in geographic location of the companies, level of gearing, and capital employed.
Estimating value of the company
To calculate the WACC, we made the following assumptions:
• Market premium is 5%
• Tax rate is 35%
• D/E = 50% (Lecture Note 4, part 2.2, Table, BT Proposed, market gearing)
o D/V = 4/12 = 33.3% ; E/V = 8/12 = 66.7%
• βa = 0.75 (from the literature )
• Risk free rate = 10.6% (from the case: rate at which government is able to borrow)
We found the use of a beta from the literature to be more accurate than the beta of a comparable, as the literature provided the beta of assets for BT in 1984, our base year. We used this beta to compute the βe using BT’s capital structure, and tax rate.
βe = βa * (1 + (D/E * (1 – tax))) = 0.99
Using the βe, a risk-free rate of 10.6%, and a market premium of 5%, we calculated the cost of equity to be 15.55%
ke = rf + βe * (risk premium) = 15.55%
Based on the information in the case, stating that the interest rate on unsecured loans varies between 12.25% and 12.75%, we assumed an average figure of 12.50% for the cost of debt. We used the debt and equity values computed in lecture note 4 : In the proposed structure of BT, the debt was £4 bn and the equity £8 bn. This corresponds to debt of 33.3% debt and 66.7% equity.
WACC = (E/V * ke) + (D/V * kd * (1 – tc))
Given these figures, the WACC was calculated to be 13%.
Free cash flow calculations
Exhibit 6 supplies the forecast for the next 5 years. We are...
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