The following information is for pedagogical purposes only and unlike earlier qu
ID: 2745932 • Letter: T
Question
The following information is for pedagogical purposes only and unlike earlier questions does not deal with real terms of the deal. In July 2016 Virgin America and ViaSat (Ticker: VSAT) announced a Joint Venture (JV) to provide Wi-Fi service on-board. ViaSat has invested $ 5 M in the venture in return for 10% ownership in the form of convertible preferred shares. By July 2017 JV is expected to generate $ 5 M in revenues with subsequent 25% annual growth. ViaSat anticipates to sell its share in JV in July 2020. Applying Value/Sales ratio of 16, what is the estimated 2020 value of ViaSat share in JV? What is the ViaSat’'s implied cost of capital that justified the $ 5 M investment? How would your answers change if the annual growth were only 20%? What is the advantage of having convertible preferred instead of common equity?
Explanation / Answer
Value of Viasat holding in 2020 = 5*1.10^3 * 16 * 10% = 10.648 million
Implied cost of capital; -5 millon = 10.648 million * PVF(4years, rate)
Rate = 20.80%
If growth rate 20%:
Value of Viasat holding in 2020 = 5*1.20^3 * 16 * 10% = 13.824 million
Implied cost of capital; -5 millon = 13.824 million * PVF(4years, rate)
Rate = 28.95%
Advantage of having convertible preferred against equity is that we get more time to decide whether we want to take higher risk by going for equity or it's safe to remain as preferred investor. Preferred holders also get priority for payment over equity holders which makes their return almost certain except very unfortunate conditions.
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