Cash Flow and Growth Rate

1796 Words Sep 10th, 2012 8 Pages
Week 8 Case Study – JetBlue Man Hon Chan 22002960
An initial public offering (IPO) refers to the initial stage of shares offering to the public market for subscriptions by a company to raise capital for the purpose of expansion. It is considered as a big issue for companies as an IPO does not necessary guarantee the success of a company as it is merely a tool of raising capital while its costs of issuance and consecutive monitoring costs (due to diluted shareholdings of the company by public investors) are relatively higher than the cost of issuing corporate debt. Yet IPO is still a popular tool for infant firms due to the fact it creates strategic market exposure. JetBlue was attempting to issue an IPO in 2002 after
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In FCFE approach, the required rate of return by shareholders is required and can be calculated using the CAPM model, which the information showed that the risk free rate (derived from yield from treasury notes) and the estimated market risk premium are 5%, the beta implemented in the CAPM model cannot be directly obtained since JetBlue has never been listed before hence a medium has to be used which the Southwest beta of 1.6 is chosen given the characteristics and nature of the two companies are similar hence is expected to be affected by similar systematic risk. The calculated required rate of return therefore would be 5%+1.6(5%)=14%. In contrast, in the FCFF approach, a weighted cost of capital (WACC) is required to use, which can be determined as the percentage of debt to equity multiply by the cost of debt plus one minus the percentage of debt to equity multiply by the cost of capital, or the required rate of return. The percentage of debt to equity is derived from the balance sheet of JetBlue as 99%. The cost of debt can only be indirectly obtained from the current debt structure of Southwest Airlines, the 7.375 debenture (with yield to maturity of 8.68%) is chosen given it is a long term debt and to remain conservative. It is assumed that the long term debt of JetBlue worth of $300m is separately obtained from three different sources. Thus the WACC is calculated as

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