You have been offered a stake in the equity of PhoneTec, a heavily levered cellu

Question

You have been offered a stake in the equity of PhoneTec, a heavily levered cellular phone company and the current income statement is as follows: The firm has a negative book value of equity and negative net income. The firm's average interest rate on the debt on its books is 10% (This is the coupon payment, i.e., the interest expense divided by the face value of the debt, which is entirely in the form of 10-year corporate bonds). The bonds are trading at a 15% discount on face value, and have a duration of 6.5 years. The average Value/EBITDA multiple for other cellular firms is 10. The treasury bond rate is 6% (You can assume that this applies to all maturities over 5 years) Estimate the value of equity in the firm, based upon the valuation of comparable firms. Now assume that the monthly variance in ln(stock prices) at PhoneTec to be 0.05 and the monthly variance in ln(bond prices) to be 0.01; the correlation between the two is 0.25, and the average debt to capital ratio during the period of the analysis was 80%. Compute the variance of firm value returns. Estimate the value of equity in PhoneTec as an option.

Explanation / Answer

EBITDA = Revenue- Operating Expense

= 12500-11000 =1500

Average Value to EBITDA of Comparables is 10

Value of Firm = EBITDA*Ratio of Industry

= 1500*10 =15000

Value of Debt= Interest/Interest Rate= 1000/10% =$10000

Market Value of Debt =10000*(1-.15) =8500

Value of Equity = Value of Firm- Value of Debt

=15000-8500 = $6500

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