Starwood Hotel - Corporate Finance

  • 29,405 views
Uploaded on

A complete valuation of Starwood hotel with all the methods of valuations. …

A complete valuation of Starwood hotel with all the methods of valuations.
1. Corporate Governance
2. Financial Analysis
3. Company Valuation
4. Capital Budgeting
5. Portfolio Assignment and assessment
6. Valuation of long term securities
7. Leasing
8. Derivatives and Options strategy
9. Capital Structure
10. Bottom up and dividend policy

  • Full Name Full Name Comment goes here.
    Are you sure you want to
    Your message goes here
    Be the first to comment
No Downloads

Views

Total Views
29,405
On Slideshare
0
From Embeds
0
Number of Embeds
3

Actions

Shares
Downloads
0
Comments
0
Likes
1

Embeds 0

No embeds

Report content

Flagged as inappropriate Flag as inappropriate
Flag as inappropriate

Select your reason for flagging this presentation as inappropriate.

Cancel
    No notes for slide

Transcript

  • 1. Corporate Finance “The Project” – Starwood Hotels and Resorts By Vipul Sonavane – MBA - Waitan
  • 2. Starwood hotels and Resorts Test of independent Board of Directors How many BoD members on the Board of your company? There is 1 member on the Board of Directors: BRUCE W. DUNCAN Chairman and President & Chief Executive Officer, First Industrial Realty Trust Inc. FRITS VAN PAASSCHEN President & Chief Executive Officer, Starwood Hotels & Resorts Worldwide, Inc ADAM ARON Chief Executive Officer, Philadelphia 76ers AMBASSADOR CHARLENE BARSHEFSKY Senior International Partner, Wilmer,Cutler & Pickering THOMAS CLARKE PH.D President, New Business Ventures, Nike, Inc. CLAYTON C. DALEY, JR. Retired Vice Chair & Chief Financial Officer, Procter & Gamble LIZANNE GALBREATH Managing Director, Galbreath & Company ERIC HIPPEAU Partner, Lerer Ventures AYLWIN B. LEWIS President and Chief Executive Officer, Potbelly Sandwich Works, LLC STEPHEN R. QUAZZO Chief Executive Officer, Managing Director & Co-founder, Pearlmark Real Estate Partners, LLC THOMAS O. RYDER Retired Chairman & Chief Executive Officer, Readers Digest Association, Inc How many of them are insiders (management) how many are “independent”? Mr. Fritsvan Paasschen is the only one insider out of all 11 members. Are the compensation and audit committees composed of entirely outsiders? Yes, they have a policy of putting at the maximum 2 board members on the audit committees. Right now there is no one from inside the company all the members are outsiders. Company Evaluation What is your company’s score and place on the list of “the world’s most admired companies”? Starwood Hotels and Resorts has a very high overall score of 7 which puts it in the top of “the 358 most admired companies”
  • 3. What is the “governance ranking” of your company on Yahoo Finance ? Starwood Hotels and Resorts’ Governance Risk Indicator (GRI®) as of Jan 1, 2013 is: Looking at the number of people on the board it’s quite a high number. But there is no concern about members of the board and members of the Audit committee as they are mostly outsiders. Compensation needs to be improvised and shareholders right is in safe hands. GovernanceMetrics International (GMI), an independent research and rating agency that evaluates corporate governance of more than 4,200 companies worldwide, assigned HOT an overall perfect 7 ranking. HOT earned high ratings in each of the categories in GMI's assessment: board accountability, financial disclosure and internal controls, shareholder rights, remuneration, market for control and corporate behavior, which includes health, environment, safety and social responsibility. Based on your findings how you assess (on a scale of 1-10) the “governance” of this company and your influence as an individual shareholder… Influence as an individual shareholder is rather limited. The biggest direct shareholder, the chairman of the Board as well as Executive Chairman Mr. Frits, holds about 0.23 million shares out of 193 million shares. Any other individual shareholders follow in a distance with less than 0.5% of the total shares. Most of the shares are owned by the Institutions and mutual funds. Show all your findings in your output and show your “process of thinking” while you were estimating your scale score… Starwood Hotel has very well distributed business in Managed hotels and Brand Franchising and licensing. They have just shifted their head quarter to ME, looking forward to the business opportunity in Middle East and in Asia. They have already entered into Asia like in India and in China. Now they are looking very close to this business in Asia and for expansion. Different brands of Starwood has won different awards in the segments like design, favourite resorts list etc. So I would like to give the company the same rating as that of Yahoo i.e. 7. Company has long term sustainability and less risk due to diversified sections. Company Holders’ Structure Did your company file any 14/DEF (SEC)? Yes, a notification to the shareholders or proxy was issued as recently as 18 April 2013. Who are the top 10-20 shareholders in your company ? Top Institutional Holders Holder Shares % Out Value* 10,434,891 5.36 598,545,347 Dec 31, 2012 Vanguard Group, Inc. (The) 9,526,023 4.89 607,093,445 Mar 31, 2013 State Street Corporation 8,980,404 4.61 515,115,973 Dec 31, 2012 Waddell & Reed Financial Inc. Reported
  • 4. Harris Associates L.P. 7,959,591 4.09 507,264,734 Mar 31, 2013 Marsico Capital Management, LLC 7,229,342 3.71 414,675,057 Dec 31, 2012 Lateef Investment Management 5,558,355 2.86 354,233,964 Mar 31, 2013 BlackRock Institutional Trust Company, N.A. 5,229,277 2.69 333,261,823 Mar 31, 2013 Morgan Stanley 5,134,154 2.64 327,199,634 Mar 31, 2013 GCIC Ltd. 3,949,823 2.03 226,561,847 Dec 31, 2012 22,248,696 11.43 1,276,185,202 Dec 31, 2012 Shares % Out Value* Ivy Asset Strategy Fund 7,689,995 3.95 441,098,113 Dec 31, 2012 Price (T.Rowe) Growth Stock Fund Inc. 3,754,564 1.93 215,361,791 Dec 31, 2012 Price (T.Rowe) Blue Chip Growth Fund Inc. 2,885,400 1.48 165,506,544 Dec 31, 2012 Vanguard Total Stock Market Index Fund 2,625,567 1.35 150,602,523 Dec 31, 2012 Vanguard Mid-Cap Index Fund 2,565,568 1.32 147,160,980 Dec 31, 2012 Vanguard 500 Index Fund 1,820,284 0.94 104,411,490 Dec 31, 2012 SPDR S&P 500 ETF Trust 1,809,384 0.93 115,312,042 Mar 31, 2013 Vanguard Institutional Index FundInstitutional Index Fund 1,795,813 0.92 103,007,833 Dec 31, 2012 Fidelity Growth Company Fund 1,445,000 0.74 87,176,850 Feb 28, 2013 Price (T.Rowe) Institutional Large Cap Growth Fund 1,441,400 0.74 82,678,704 Dec 31, 2012 Price (T.Rowe) Associates Inc Top Mutual Fund Holders Holder Major Direct Holders (Forms 3 & 4) Holder Shares Reported VAN PAASSCHEN FRITS D 238,536 Feb 27, 2013 PRABHU VASANT M 156,033 Apr 10, 2013 DUNCAN BRUCE W 43,691 Mar 30, 2013 Reported
  • 5. TURNER SIMON 103,938 Mar 27, 2013 93,676 Feb 29, 2012 AVRIL MATTHEW E Annual Report According to Starwood Hotel annual report they have two main segments and revenue is divided into 4 segments: Owned, leased and consolidated joint venture hotels, Vacation ownership and residential sales and services, Management fees, franchise fees and other income, Other revenues from managed and franchised properties. These segments are again divided into the regions as mentioned in chart below. USA has the major stake in sales revenue for Starwood hotel. Segment Analysis StarWood Hotels and Resorts Managed Hotels. Brand Franchising and Licensing. United States 33.50 % United States 69.90 Asia Pacific 30.50 % Europe Middle East and Africa Latin America, Caribbean & Canada 14.80 % Latin America, Caribbean & Canada Asia Pacific 12.70 % Europe 7.00 8.50 % Middle East and Africa 0.50 Total Country Canada Italy Spain Australia Mexico 13.60 9.00 100.00 % Total 100.00 2012.00 2011.00 2010.00 2011.00 2009.00 2008 Revenues Revenues Revenues Revenues Revenues Revenues 11.40 11.00 10.80 11.00 9.30 9.00 6.70 7.40 7.10 7.40 7.60 8.50 6.10 5.90 5.60 5.90 5.30 4.80 5.00 4.90 4.10 4.90 4.70 5.40 4.60 4.20 4.10 4.20 2.80 2.80 Business Risk Assessment:
  • 6. Starwood is Subject to All the Operating Risks Common to the Hotel and Vacation Ownership and Residential Industries. Operating risks commonto the hotel and vacation ownership and residential industries include e.g.: • changes in general economic conditions, including the severity and duration of downturns in the United States, Europe and global economies; • impact of war and terrorist activity (including threatened terrorist activity) and heightened travel security measures instituted in response thereto; • domestic and international political and geopolitical conditions; • travelers’ fears of exposures to contagious diseases; • decreases in the demand for transient rooms and related lodging services, including a reduction in business travel as a result of general economic conditions; If Starwood is Unable to Maintain Existing Management and Franchise Agreements or Obtain New Agreements on as Favorable Terms, OurOperating Results May Be Adversely Affected. They are impacted by their relationships with hotel owners and franchisees. Their hotel management contracts are typically long-term arrangements, but most allow the hotel owner to replace them in certain circumstances, such as the bankruptcy of the hotel owner or franchisee, the failure to meet certain financial or performance criteria and in certain cases, upon a sale of the property Starwood and their third party licensees may not be able to sell residential properties using their brands for a profit or at anticipated prices. Assets development: We use the data for the past 5 years as I assume this is most representative for the valuation of the company. There is no particular growth pattern for the total Asset as the long term asset is volatile. Following is the breakdown and range of the asset: Current Assets Cash And Cash Equivalents Short Term Investments Net Receivables Inventory Prepaids & Other Current Assets Total Current Assets Long Term Investments/Investment in Unconsolidated affiliates Land & Improvements Buildings & Improvements Airplanes FF&E Leasehold Interest in land Gross PPE Accumulated Depreciation Property Plant and Equipment 305 320 586 361 454 278 569 812 753 87 389 513 802 447 783 552 986 347 1,919 421 2,534 238 2,306 174 1,491 239 2,166 5,584 -2,422 3,162 5,783 -2,513 3,270 5,971 -2,648 3,323 5,823 (2,473) 3,350 6,070 (2,471) 3,599
  • 7. Net Goodwill Intangible Assets, Net Accumulated Amortization Other Assets Equity and other investment Investment in unconsolidated affiliates Deferred Income taxes 1427 598 - 2,067 2,057 - 2,063 2,235 - - 859 260 789 312 531 344 1,064 - 636 Total Assets 801 259 639 979 982 639 8,761 9,703 8,861 9,560 9,776 Total Asset million USD 10000 9800 9600 9400 9200 Total Asset million USD 9000 8800 8600 2007 2008 2009 2010 2011 2012 2013 Assets financing: Starwood’s asset was mainly financed by the equity. The total-debt ratio is 34%, which acknowledges that total assets are financed for 34% by total debt. Sales growth: Sales have grown at an annual growth rate of around 10%. On the chart we can see a rapid growth in sales interrupted by a major drop in 2009, due to the financial crisis. Segment wise Sales revenue:
  • 8. 3000% 2500% 2000% Expected Growth ROC 1500% Reinvestment 1000% Beta 500% 0% 35.00% 35.00% 35.00% Total Sales revenue trend: Total Sales Revenue 7,000 6,000 5,000 4,000 Sales Revenue 3,000 2,000 1,000 2007 2008 2009 2010 2011 2012 2013 Profitability: Profit margin varies from 8.9% high in 2011 to a 0% low in 2009 and ends with an average 5.38% in 2011. 2009 was a recession year and company could not perform well and lost the profit margin.
  • 9. Net Profit Margin 10.00% 9.00% 8.00% 7.00% 6.00% 5.00% 4.00% 3.00% 2.00% 1.00% 0.00% -1.00% 8.93% 7.44% 6.13% 4.41% 2012 2011 2010 Profit Margin -0.02% 2009 2008 Cash generation and usage: At December 31, 2012, Starwood had approximately USD1.2 billion in cash on hand. Income and cash flows are largely dependent on debt, relation between franchisee, recession period, Debt because of leasing etc. Starwood believes that cash on hand and cash generated from operations will be sufficient to fund its operating needs and planned capital expenditures, (Form 10-K, 2012) Cash and cash equivalents at end of year has jumped after the financial crisis, from USD 0.5 billion in 2009 to USD1.2 billion in 2012 Cash and cash equivalent 1400 1200 1184 1000 800 600 764 646 400 571 641 Cash and cash equivalent 200 0 Total Growth Assets: Starwood has a market capitalisation of USD12 billion. We calculate this amount by multiplying the total outstanding shares (193 million) with the stock price (62.09 per 29 March 2013). We replace
  • 10. the book value of total stockholders’ equity with the market capitalisation and then calculate the Total Growth Assets. Starwood has a total growth in assets of 65%. (Form 10-K, 2012) Total Assets in Place 8.8 B USD (60%) Total Growth Assets 2 B USD (40%) Total Debt 1.6 B USD (34%) Total Equity 3.1 B USD (66%)
  • 11. Ratio Analysis 2012 Liquidity ratios Current ratio Quick ratio 2011 2010 2009 2008 0.95 0.48 1.27 0.58 1.07 0.70 0.74 0.35 0.81 0.44 2.00 1.72 1.53 1.41 1.60 0.71 0.59 0.52 0.54 0.59 0.63 4.64 0.68 3.14 0.73 2.44 0.79 -0.29 0.78 2.59 Profitability ratio Profit Margin on Sales ROE ROA 7.44% 0.1498 0.71 8.93% 0.1699 0.59 6.13% 0.1259 0.52 -0.02% -0.0005 0.54 4.41% 0.1567 0.59 Market Value ratio EPS P/E Book value per share Market to Book ratio $2.91 20.38 $16.25 3.65 $2.59 18.66 $15.63 3.09 $2.61 22.99 $13.50 2.61 $0.41 86.97 $10.13 3.48 $1.82 10.95 $8.96 2.22 Asset ratios Fixed Asset turnover ratio Total Asset turnover ratio Debt Ratios Debt ratio Time interest ratio Company Valuation Regression Beta Calculation I performed a regression to calculate the Beta for HOT, based on the 5 years monthly return of HOT stock. I used the leading S&P500 index as a reference to compare the performance of the HOT stock vis-à-vis the market. Also I cross verified with the slope function. SUMMARY OUTPUT Regression Statistics Multiple R 0.720135 R Square 0.518595 Adjusted R Square 0.514712 Standard Error 0.077167 Observations 126 ANOVA
  • 12. df Regression Residual Total Intercept X Variable 1 1 124 125 Coefficients 0.006771 1.871854 Significance SS MS F F 0.795438 0.795438 133.5792 2.04E-21 0.738395 0.005955 1.533833 Standard Error t Stat P-value 0.00693 0.97708 0.330432 0.161958 11.55765 2.04E-21 Upper Lower Upper Lower 95% 95% 95.0% 95.0% -0.00695 0.020487 -0.00695 0.020487 1.551294 2.192414 1.551294 2.192414 When plotting the results in a graph of residuals, we can clearly see the regression line with coefficient 1.87 0.5 0.4 Residuals 0.3 0.2 Series1 0.1 Linear (Series1) 0 -20.0000% -10.0000% 0.0000% 10.0000%20.0000% -0.1 -0.2 X Variable 1 Cost of Capital – WACC Calculation of cost of capital using the Market value of equity and debt. HOT Pre income tax Income tax Tax rate Total debt r(debt) Rf - 10yr Bonds DRP - credit rating BBB r(equity) Rf - 10yr Bonds 2012 618 148 23.95% 3695.00 2.86% 1.76% 2.00% 12.57% 1.76% 2011 427 -75 -17.56% 4614.00 4.56% 1.88% 2.00% 13.17% 1.88% 2010 338 27 7.99% 5144.00 4.87% 3.29% 2.00% 13.01% 3.29% 2009 -291 -290 99.66% 4910.00 0.02% 3.84% 2.00% 11.99% 3.84% 2008 326 72 22.09% 5394.00 3.28% 2.21% 2.00% 14.23% 2.21% Assumptions www.damodaran.com www.damodaran.com www.damodaran.com
  • 13. Beta ERP Total Equity Stock price Oustanding shares Total Debt + Total Equity 1.87 5.78% 3137 59.35 193 6832.00 Capital Structure (D+E) Wd We 100.00% 100.00% 100.00% 100.00% 100.00% 54.08% 60.97% 67.55% 72.91% 76.89% 45.92% 39.03% 32.45% 27.09% 23.11% WACC = wd*rd*(1tax)+we*re 1.87 6.04% 2954 48.28 189 7568.00 6.95% 1.87 5.20% 2471 59.93 183 7615.00 8.41% 1.87 4.36% 1824 35.27 180 6734.00 7.25% 3.25% 1.87 6.43% www.damodaran.com 1621 17.13 181 7015.00 5.25% Free Cash Flow Calculation I calculate the Free Cash Flow from EBIT using financial data found in the 10-K annual report. 2012 1184 -362 Operating Cash flow Capital Expenditure FCF = Operating Cash Flow Capital Expenditure 2011 641 -385 2010 764 -227 2009 571 -196 2008 646 -476 822 256 537 375 170 On the graph we can see a knack in 2009 due to the financial crisis. FCF 900 822 800 700 600 537 500 400 FCF 375 300 256 200 170 100 0 2012 2011 2010 2009 Short term and long term period of future cash flow: Tax 20122016 35.00% 20172021 35.00% LT 35.00% 2008
  • 14. Expected Growth ROC Reinvestment Beta 8% 25.72 56% 1.87 Cost Of Capital 7.45% Declining Declining Declining 1.70 7.30% 5% 12% 38% 1.50 5.10% Assumptions: Tax: Tax rate is 35% on average in the past and predicted to stay the same in the future. Expected Growth: EBIT growth will continue in the first 5 years as the company has healthy financials and just invested heavily in new growth opportunities - hence the high capex in 2012. I expect the EBIT growth to slow down to about 3%, ROC and Reinvestment: Using last year’s Return on Capital, looking at the expansion plans I don’t think that ROC will be maintained it will get declined. Both rates will decline linearly to a sustainable long term rate. Beta: Beta on the long term will decline to market beta of 1.5. Cost of Capital: Will remain around 7% in the short time and transition period, while declining to 5.1o% for the long term due to a more optimal debt-equity structure. See Capital Structure Model EBIT NOPAT Reinvestment FCFF PV 2012 11,662 6,997 3,903 3,094 2,853 2013 12,644 7,586 4,231 3,355 2,852 2014 13,708 8,225 4,588 3,637 2,851 2015 14,861 8,917 4,974 3,943 2,850 2016 16,112 9,667 5,392 4,275 2,850 Transition Period and Long Term – 2017 to 2021 and in perpetuity 2012 1232.59 5 2013 1355.85 5 2014 1491.4 4 -2422 2591.54 2772.9 5 -2967.05 3174.75 - Capital Expenditu res -1646 1761.22 1884.5 1 -2016.42 - Change in WC -149 47.4075 605.595 478.127 EBIT (1-t) + Depreciati on = FCFF Terminal Value (in '05) Value of the Firm 52.148 25 550.84 93 2015 1640.584 57.36308 632.5875 2016 1804.64 2 2017 1985.10 7 2018 2095.47 8 2019 2020 2193.17 2275.5 1 72 2021 2340.29 9 3396.98 3627.97 - 4114.9 3867.42 4 4370.06 2157.57 -2308.6 2476.87 2645.14 2813.4 2981.67 63.0993 8 724.365 3 69.4093 2 827.317 1 70.2422 3 874.129 6 70.0345 68.687 6 23 900.851 905.35 7 28 66.1277 3 885.781 8
  • 15. After adding cash and subtracting the market debt from the total present values of the future free cash flows, I get to the Firm Value. Divided by outstanding shares, I get the Value per Share of the firm. PV of EVA + Capital Invested + PV of Chg Capital in Yr 10 = Firm Value(Mil USD) # of shares (Mln) Value per share($) 3598.863 2120 4874.732 10593.6 197 53.7746 Stock Analysis Expected Return on Stock Using 5 year annual returns on the company stocks, I came to the following result for the Expected return and risk of the stock. STDEV 11.08% Expected RET 14.19% See Addendum for detailed research and analysis. 3 Stock Portfolio For the 3 stock portfolio I chose my company Starwood Hotel and resorts, active in the major consumer discretionary mainly in hotel industry. I compared this with consumer staples a house hold industry company Kimberly clark and then this I have compared with Finally, I compared this portfolio with the telecommunication services company which work in technology i.e. Century link Inc. (website: http://www.sectorspdr.com/correlation/) To compare the 3 stocks, I first developed scenarios to compute the expected returns of the stock and their risk or Standard deviation. Good Normal Bad Awful (2005/2006/2007) (2004/2008/2011/2012) 2009 2010 I used the leading S&P500 index to develop 4 scenarios: good, normal, bad and awful. Using these 4 scenarios, I am then able to calculate the Expected returns and risks for each stock respectively. HOT Return Probability*Return Probability*[Return-E(ri)]^2 1.67% 0.56% 1.22%
  • 16. 2.44% 105.37% 67.03% 1.09% 11.71% 7.45% E(Return of HOT)= 1.50% 7.95% 2.37% 23.50% Std(HOT)= 11.25% KMB Probability*[ReturnReturn Probability*Return E(ri)]^2 5.35% 1.78% 0.05% 8.95% 3.98% 0.00% 26.18% 2.91% 0.33% 3.25% 0.36% 0.04% E(Return of KMB)= 12.38% Std(KMB)= 3.93% CTL Probability*[ReturnReturn Probability*Return E(ri)]^2 7.40% 2.47% 0.01% -5.05% -2.24% 0.93% 44.93% 4.99% 1.40% 38.00% 4.22% 0.91% E(Return of CTL)= 9.52% Std(CTL)= 6.27% I then develop the Covariance Matrix for my 3 stocks. HOT KMB CTL HOT KMB 1.27% 2.47% 0.20% 2.47% 0.15% 1.05% CTL 0.20% 1.05% 0.39% And finally, I can find the Minimum Variance Portfolio for 3 stocks. Std(Rp) E(Rp) HOT KMB CTL
  • 17. 7.85% 13.89% 29.00% 11.00% 60.00% E(Rp) 0.25 0.2 0.15 E(Rp) 0.1 0.05 0 0 0.02 0.04 0.06 0.08 0.1 0.12 0.14 Market Valuation of Debt Assuming a 100% redemption value and par value is USD100. Settle Date Maturity Coupon Bond Price Redemption Value Coupon Payments per year YTM Calculated bond price HOT 02-042013 02-042014 0.1000 111.10 90 2 -0.11 108.00 HOT 02-042012 15-052018 0.0675 121.90 100 2 2.15 2.92 371 HOT 02-042012 15-022023 0.0313 99.40 100 2 3.20 2.93 Value outstanding (million) 200 Notes outstanding (million) Market value Debt (million) 12.34 3.71 3.50 2.05 120.00 451.88 347.90 256.41 Total Market Value Debt 1,176 Growth rate of Earnings per Share All data can be found in the 10-K annual report 350 HOT 02-042012 12-012019 0.0715 125.20 100 2 0.03 125.20 205
  • 18. Net Income Total Equity ROE 323 1971 16.39% Retained Earning Retention ratio 126 57% DPS EPS Retention ratio 1.25 1.34 55% G(EPS) 19% Dividend Valuation: 2008 Dividen d EPS Payout Ratio g DCF 2009 2010 2011 0.90 1.82 0.20 0.41 0.30 2.61 0.50 2.59 49.51% -77.78% 15.75% 1.157541 49.32% 50.00% 11.17% 1.111732 1.2359480 4 0.2471896 08 11.51% 66.67% 13.33% 1.13334 1.4557293 93 0.4367188 18 19.33% 150.00% 14.71% 1.147148 1.5095877 29 0.7547938 64 1.157541 1.041786 9 Share Price 2012 2013 1.25 1.38 2.91 42.93% 10.00% 12.75% 1.127486 1.6160121 88 2.0200152 34 50.03 54.52597 2 Share is overvalued because current price of the share is $62.1. Leasing and Valuation Lease Converter The operational lease can be considered as of-the-balance financing and should therefore be incorporated as debt. Using Damodaran’s valuation lease converter to process financial data found in the 10-K annual report, we come to an adjusted operating income. Pre-tax Cost of Debt = 2.61% From the current financial statements, enter the following $ Reported Operating Income (EBIT) = 912.00 Reported Debt = $ ! This is the EBIT reported in the current income statement ! This is the interest-bearing debt reported on
  • 19. 2,174.00 $ 170.00 Reported Interest Expenses = Output Number of years embedded in yr 6 estimate = 11 Converting Operating Leases into debt Present Year Commitment Value $ $ 1 95.00 92.58 $ $ 2 85.00 80.73 $ $ 3 100.00 92.56 $ $ 4 67.00 60.44 $ $ 5 100.00 87.91 $ $ 6 and beyond 87.55 727.75 Debt Value of $ leases = 1,141.97 Adjustment to Operating Income + Current year's operating lease expense = - Depreciation on leased asset = Adjusted Operating Income the balance sheet ! I use the average lease expense over the first five years to estimate the number of years of expenses in yr 6 ! Commitment beyond year 6 converted into an annuity for ten years $1,410.00 $71.37 $1,338.63 New Firm Value: Value of Firm $ 13,568 - Value of Debt $ 1,943 Value of Equity Value of Equity per Share $ 11,625 $ 60.23
  • 20. Options Strategy: 1.2 1 0.8 0.6 0.4 0.2 0 150 100 Strategy: If we look at the share prices in last three months price is moving from 59 to 63. And as Starwood is moving their head quarter to ME there are huge chances that price will shoot up. But it will take some time. So for the short term period price will move in same range so I would like to go for a Strangle i.e. buying two calls but for different strike price. Strike Price Premium Buy HOT call May 2013 55 Sell HOT call May 2013 65 Amount Investment 623 100 62300 439 200 87800 Total 150100 CALL Buy Sell Premium P 6.23 Strike Price X No. of call Premium P 4.39 55 Strike Price X 65 1 No. of call Total 1 Observatory Prices 57 -4.23 4.39 0.16 59 -2.23 4.39 2.16
  • 21. 60 -1.23 4.39 3.16 61 -0.23 4.39 4.16 62 0.77 4.39 5.16 63 1.77 4.39 6.16 64 2.77 4.39 7.16 65 3.77 4.39 8.16 Black-Scholes Model: Using options with the following details in the Black-Scholes model, I came to the conclusion that the call option, with exercise price of USD67.5 and maturity on 13 May 2013, is worth USD0 3 today. However, the call option is priced USD 0.27 on the market which is very underpriced Using the same logic, a put option with exercise price of USD 67.5 and maturity on 13 May 2013 is worth USD 7.14 today which is priced on USD 6.65. Stock Price Exercise Price Interest Rate Dividend Yield Time to Expiration Standard Deviation $ $ decimal decimal decimal decimal 61.88 67.5 0.10 0.02 0.25 0.37 PROCESS d1 d2 NORM d1 NORM d2 -0.2680617 -0.4535617 0.39432591 0.32507216 CALL $ 3.00 PUT $ 7.14 Leverage of Beta: Unlevered Beta for the firm (based upon average debt/equity ratio) = Current Beta for the firm (based upon current debt/equity ratio) 1.07 1.51
  • 22. = Debt to Capital 0.00% 10.00% 20.00% 30.00% 40.00% 50.00% 60.00% 70.00% 80.00% 90.00% Debt/Equity Ratio 0.00% 11.11% 25.00% 42.86% 66.67% 100.00% 150.00% 233.33% 400.00% 900.00% Beta 1.07 1.14 1.24 1.36 1.52 1.75 2.09 2.66 3.79 7.20 Effect of Leverage 0.00 0.08 0.17 0.29 0.45 0.68 1.02 1.59 2.73 6.14 Capital Structure: Capital Structure Current MV of Equity = Market Value of interestbearing debt = # of Shares Outstanding = Debt Value of Operating leases (if any) Risk Premium = $11,455 Financial Market Current Beta for Stock = 1.87 Current EBITDA = $1,039 $2,062 Current Bond Rating = Baa2/BBB Current Depreciation = $251 Current Tax Rate = 35.00% 193 $0 5.78% Income Statement Summary of Inputs Long Term Government Bond Rate = 1.76% Pre-tax cost of debt = 19.08% Current Capital Spending= Current Interest Expense = $362 $170 Looking at the adjusted value of the firm the value is getting increased till it reaches the point where it starts decreasing again. It happens when Debt ratio is in between 50% to 60%. Debt Ratio 0% 10% 20% 30% 40% 50% 60% 70% 80% $ Debt $0 $1,352 $2,703 $4,055 $5,407 $6,758 $8,110 $9,462 $10,81 Adjusted Present Value Estimates Unlevered firm Tax Benefits from Expected Bankruptcy value Debt Cost $12,879 $0 $2 $12,879 $187 $1 $12,879 $374 $1 $12,879 $561 $6 $12,879 $748 $8 $12,879 $935 $34 $12,879 $1,122 $515 $12,879 $1,309 $651 $12,879 $1,495 $1,045 Levered Firm Value $0 $4,663 $4,850 $5,032 $5,217 $5,378 $5,084 $5,135 $4,928
  • 23. 90% 3 $12,16 5 $12,879 $1,682 $1,078 $5,082 Rating of the company changes as per below table: Ratings comparison at current debt ratio Current Interest coverage ratio = 4.64 Rating based upon coverage = A3/AInterest rate based upon coverage = 5.06% Current rating for company = Baa2/BBB Current interest rate on debt = 19.08% Current Bankruptcy Probability = 2.50% The below table shows how the value of the firm changes and how the rating varies if it starts taking more debt. Since WACC is the component of the after tax cost of debt and the cost of equity. Generally cost of debt is less than cost of equity so that the weighting which we take decreases the WACC initially until it reaches the optimal point then it shoots up. This increase is due to the loop structure taken by the cost of debt calculation, which is the component of interest rate decided as per company’s rating and the spread. With increase in debt both interest rates to borrow the money and spread increases, which drops the rating of the company. Debt Ratio 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% $ Debt $0 $1,352 $2,703 $4,055 $5,407 $6,758 $8,110 $9,462 $10,813 $12,165 Tax Rate 35.00% 40.00% 40.00% 40.00% 40.00% 40.00% 40.00% 40.00% 40.00% 40.00% Unlevered Firm Tax Bond Probability of Value Benefits Rating Default $12,879 $0 AAA 0.07% $12,879 $187 Aaa/AAA 0.07% $12,879 $374 Aaa/AAA 0.07% $12,879 $561 Aa2/AA 0.51% $12,879 $748 A1/A+ 0.60% $12,879 $935 A3/A2.50% $12,879 $1,122 Ba1/BB+ 36.80% $12,879 $1,309 B3/B45.00% $12,879 $1,495 Ca2/CC 70.00% $12,879 $1,682 Ca2/CC 70.00% Expected Value of Bankruptcy Levered Cost Firm $2 $12,877 $1 $4,663 $1 $4,850 $6 $5,032 $8 $5,217 $34 $5,378 $515 $5,084 $651 $5,135 $1,045 $4,928 $1,078 $5,082