Jet Taxi is an air taxi company that caters to wealthy individuals, executives,
ID: 2805153 • Letter: J
Question
Jet Taxi is an air taxi company that caters to wealthy individuals, executives, and celebrities. The entity acquires commercial jet aircraft from various manufacturers and other parties and provides air taxi services worldwide. As of December, 2016, Jet Taxi managed a portfolio of over 1,000 aircraft. Jet Taxi is wholly owned by Western Holdings, a global tourism company.
Cost of Capital
Western Holdings is publicly traded and its equity beta is 2. The equity beta for Jet Taxi is not observable because the entity’s stock is not publicly traded. There are, however, a number of publicly traded air taxi companies. The data for two such companies are given below. The Jet taxi operations are 50% equity financed and have a marginal tax rate of 40%. The cost of borrowing for Jet Taxi is 6%.
At the present time, the long-term U.S. Treasury bond rate is 5%. Based on historical data, most analysts believe that a reasonable estimate of the market risk premium (i.e., Rm – rf) is 7.5%.
In order to value Jet Taxi CEO Goldstein needs an estimate of WACC for Jet Taxi.
Air Taxi Companies
Company
Beta Equity
D/E Ratio
Marginal Tax Rate
Levent Jets
2.0
0.5
0.4
Mert Jets
1.5
0.3
0.4
1. What is the WACC for Jet Taxi?
Company
Beta Equity
D/E Ratio
Marginal Tax Rate
Levent Jets
2.0
0.5
0.4
Mert Jets
1.5
0.3
0.4
Explanation / Answer
First we will make summary of data given:-
Jet taxi
Rf (Us treasury bond) = 5%
(Rm-Rf) (market risk premium) = 7.5%
debt equity ratio = 1 (as it is 50% equity financed)
Tax = 40%
Kd(cost of borrowing) = 6%
Other Air Taxi Companies
Company
Beta Equity
D/E Ratio
Marginal Tax Rate
Levent Jets
2.0
0.5
0.4
Mert Jets
1.5
0.3
0.4
Solution
To calculate cost of equity the first step is to unlever the betas of of the comparable companies and calculate an average.
This method is called pure play method
As we cannot use the beta of western holding because it can also have other business factors (i.e. other than air taxi business).
Pure play method formula
= Blevered = Bunlevered {1 + Debt (1-tax)}
Equity
= Bunlevered = Blevered .
{ 1 + D(1-tax)}
E
Calculating unlevered Beta of comparable company
Levents Jets
= 2 . = 1.538
(1+(.5(1-.4))
Mert Jets
= 1.5 . = 1.271
(1+ (.3(1-.4))
Take average of above 2 unlevered beta
(1.538 + 1.271)/2
= 1.40
Now we will calculate levered beta of jet taxi using above unlevered beta
= 1.40[ 1 + 1(1-.4)]
= 2.24
Now normally calculate WACC
Ke = Rf + (Rm – Rf)beta levered = 5 +(7.5)2.24 =21.8
Kd = cost of debt (1- tax) = 6(1-.4) =3.6
We= 50%
Wd= 50%
= .5*21.8 + .5*3.6
=10.9 + 1.8
=12.7%
Company
Beta Equity
D/E Ratio
Marginal Tax Rate
Levent Jets
2.0
0.5
0.4
Mert Jets
1.5
0.3
0.4
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