Valuation Of British Telecom 1984
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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:
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Market premium is 5%
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Tax rate is 35%
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D/E = 50% (Lecture Note 4, part 2.2, Table, BT Proposed, market gearing)
D/V = 4/12 = 33.3% ; E/V = 8/12 = 66.7%
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ОІa = 0.75 (from the literature )
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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 ОІe, 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 + ОІe * (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 ÐЈ4 bn and the equity ÐЈ8 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 starting from 1985 (as we are currently at 1984).
In order to calculate the FCF of each year:
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NOPLAT = Pretax profit — tax + Changes in differed taxes
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Differed taxes = tax — tax payable
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We assumed CAPEX is equal to the additional to fixed assets
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Based on Exhibit 6 we assume that the change in WCR is 0
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FCF = NOPLAT + Depreciation — CAPEX — increase WCR
We forecasted 1989 in order to extend our short term horizon to 5 years. Our assumptions were:
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Revenues will continue to grow at about 8%
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Costs will continue to grow at about 8%
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Depreciation will continue to grow at about 10%
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Corporate tax is 35% (not taking into account the first two years in the forecast)
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Fixed assets will not grow substantially (at a fixed rate)
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Tax payable will grow at decreased pace
We used the same assumptions to estimate the NOPLAT for 1990, in order to use it in the terminal value calculation.
The terminal value was based on the Value Driver Formula
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We already calculated WACC = 13%
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We assumed RONIC = WACC = 13% (BT is a normal growing firm)
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