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Component
Net Income (M$)
Earnings per share (EPS)
# of shares (M)
Price per share
Market Value – Equity (M)
Market Value – Debt (M)
Market Value – Total (M)
– % Debt
– % Equity
Beta (levered)
Beta (unlevered)
Average Beta (unlevered)
Values for Wilson:
% Debt
% Equity
Beta (relevered)
Risk free rate
Market risk premium
Expected equity return (CAPM)
Expected cost of debt
Tax rate
Weighed average cost of capital (WACC)
Maxwell
21.00
2.40
11.00
44
0.88
40.0%
2.0%
6.0%
5.5%
21.0%
Barston Notes
19.00
3.00
Net Income / EPS
15.00
# of shares x price per share
99
MV = Equity MV + Debt MV
Debt as a per cent of Total MV
Equity as a per cent of Total MV
0.92 as reported in Value Line
Beta (levered) x % Equity
Average of the two Beta (unlevered)
Income Statement (in ‘000 $)
Growth rates:
Parts Sales
Service Program
Parts Sales
Service Program
Actual
2020
2021
Projected
2022
2023
2024
2025
3.0%
5.0%
3.0%
6.0%
4.5%
7.0%
5.0%
7.0%
4.0%
7.0%
Notes
2,223
2,142
Total Operating Revenues
4,365
Salaries and benefits
Research and development
Service expense
Sales and Administrative
Depreciation/amortization
995
922
565
437
374
Total Operating Expenses
3,293
Income before taxes
Income tax expense/(benefit)
Net Income
Cash and investments
Accounts receivable
Inventory and supplies, net
Other
1,072
225
847
Balance Sheet
1,934
1,249
1,045
192
Current Assets
Other
Total Assets
4,420
5,932
10,352
Bank Loan
Payables
CPLTD
Other
4,049
248
44
93
Current Liabilities
LTD
Equity
Total Liabilities & Equity
4,434
1,877
4,041
10,352
Working Capital
4,035
Increase at a
yearly rate of
3.0%
5.0%
4.5%
3.0%
3.0%
Increase at a
yearly rate of
5.0%
4.0%
5.0%
5.0%
Increase at
5.0%
Plug account
Increase at a
yearly rate of
Exclude Bank Loan
5.0%
2.0%
2.0%
Free Cash Flow Valuation
(in ‘000 $)
Income before taxes
+ Interest
2021
2022
2023
2024
2025
TV
= Income before interest and taxes (EBIT)
EBIAT
– Change in Working Capital
– Change in Other assets
Free Cash Flow (FCF)
PV of FCF = EV
– Existing Debt
= Value of equity
Growth rate
3.0%
No content – Intentionally left blank
Wilson Aviation: Valuing a Business
Alfonso F. Canella Higuera
October 18, 2021
Daniel Rouse was a fixture at the Deerfield Airport in central California. Daniel, now 50
years old, had started working there when he was in high school, continued working there through
college at Cal Poly in San Luis Obispo, and continued using the airport, flying his Cessna there
during visits from southern California, where he was working as an engineer for Boeing.
Daniel had just taken an early retirement package and decided to go home. So, one day, he
flew his Cessna back, tied it down, and never looked back at southern California again. He renovated
his parents’ home, some two miles from Deerfield Airport, and stayed there for good. He loved the
area, the weather, the scenery, the laid-back atmosphere, and, yes, the access to the airport. Oh, and
everyone knew Daniel and appreciated him!
The weeks passed after his arrival and Daniel grew restless. He had worked long and hard
at Boeing and it was difficult to change gears. He wanted something to do and was wondering what
it would be. That evening, while hanging out at the airport’s restaurant, he was offered the purchase
a business that sold aircraft controls to Boeing. Daniel could only remark “the apple doesn’t fall far
from the tree, does it?”
The firm’s owner, Harlan Wilson, 78, had known Daniel for decades and loved him like a
son. Seeing that Daniel had moved to the area for good, Harlan, also a Cal Poly alum, had 5 children
but they were not interested in engineering or flying or moving to Central California or running a
business. And since his 12 grandchildren were his heirs, he had to sell the firm to help fund their
college educations. So, it made sense to see if Daniel, whom Harlan trusted implicitly, would
continue the business and keep it locally owned. Daniel’s engineering experience at Boeing certainly
helped smooth the transition to a new owner.
And so it was. Daniel was very receptive and Harlan offered to give him the firm’s financials
so Daniel could figure out a purchase price. Harlan had a notion of the price of his firm (an even
million) but he hadn’t run the numbers. He wouldn’t run them anyway; Harlan knew that Daniel’s
honesty was as long as a summer day and he knew they’d work out a fair price without bringing in
an appraiser.
Harlan knew Daniel might not have the money required to buy the business outright. He
understood, rightly, that a lot of Daniel’s net worth was tied up in retirement accounts that would
trigger a large tax bill if they were cashed out. So, Harlan threw in a sweetener: “I’ll keep 50% of
the equity in the business and you can pay me 5% on it for the first 5 years. At the end of those 5
years, buy me out for what we calculate the 50% is worth today.”
The proposal was clever – Harlan would earn a sure 5% on his money, which was clearly
higher than he could expect on his Treasury investments. Also, with the extra equity, Daniel could
borrow at a lower rate from the bank as the firm would have little debt. It was a win-win.
Daniel accepted and they wrote the terms of the agreement on the restaurant’s paper table
covering. After signing on the terms, Daniel and Harlan walked over to Wilson Aviation’s offices
so that Harlan could give him the financials.
The next day, Daniel sat down and started going through Wilson Aviation’s financials. These
financials would help him generate the free cash flow projections (FCF) that he could then present
value to get the enterprise value (EV) of Wilson Aviation. To remind himself of the entire process,
he wrote on the dry erase board in his office what he needed to do:
1. Calculate the weighed average cost of capital (WACC):
a. Estimate the appropriate cost of debt and the amount of debt for Wilson after the
purchase and the tax rate to be applied
b. Estimate the cost of equity for a firm like Wilson Aviation; this would require using
the Capital Asset Pricing Model (CAPM)
c. To use the CAPM, Daniel would need to estimate Wilson’s beta (ß), which is the
firm’s covariance of returns relative to the overall stock market. Daniel would also
need the 10-year Treasury rate as a stand in for the risk-free rate and the stock
market’s historical returns over and above the risk-free rate (this was called the
market premium)
2. Forecast the firm’s income statement for the next 5 years
3. Use the results from the income statement to forecast the firm’s balance sheet and use the
numbers generated to calculate the working capital for each year
4. Generate the FCF as follows:
a. Get the Income Before Taxes from the income statement
b. Add to these the interest paid by adding the Bank Loan, Current Portion of Long
Term Debt (CPLTD), and Long Term Debt (LTD) together and multiplying that by
the debt interest rate used in the WACC calculation
c. The sum of Income Before Taxes and the interest paid is now equal to Earnings
Before Interest and Taxes (EBIT)
d. Subtract the actual taxes paid from EBIT to get Earnings before Interest and After
Tax (EBIAT)
e. Subtract the increases from year to year of Working Capital from EBIAT
f. Subtract the increases from year to year of Other Assets from EBIAT (this is a proxy
of capital expenditures)
g. Once the two subtractions are done, you are left with the FCF
h. Use the perpetuity formula to calculate the terminal value (TV); in this case, apply a
long term growth rate of 2.5% as a higher growth rate was not appropriate and would
also high too high an EV
i. Use the NPV function of Excel with the WACC as the discount rate to get the present
value of the FCF
j. Subtract the 2020 values for Bank Loan, CPLTD, and LTD to get the dollar value of
equity
Daniel started from the top by commencing to calculate Wilson Aviation’s WACC.
Because Wilson was privately owned by Harlan, it had no stock price data. So, Daniel would have
to start from scratch. The formula for the WACC is:
[% Debt x Cost of Debt x (1 – tax rate)] + [% Equity x Cost of Equity]
Page 2 of 7
work:
Daniel had done some research since his retirement and had some notions of what would
% Debt = 25%
Cost of debt = 4.9%
Tax rate = 21%
% Equity = 75% (basically, it was 1 – % Debt)
Cost of Equity = ???
He needed to come up with a way to calculate the cost of equity for Wilson. Since it wasn’t
traded, he had no beta (ß) to plug into the Capital Asset Pricing Model (CAPM) that allows analysts
to come up with an expected return on equity:
Cost of Equity = Risk-Free Rate + [Beta x Market Premium]
He had checked out the internet and found out the following:
Risk-Free Rate = 2.0% (10-year Treasury)
Market Premium = 6.0% (a historical average that varied based on what years were averaged)
Beta = ???
Daniel needed to get a beta but how? He emailed his old professor at Cal Poly as he suspected
that he might know. The professor replied that Wilson Aviation had two major competitors in its
industry, Maxwell and Barston, and they had public data that could be used to back into the
industry’s average beta. He gave the data to Daniel, who then put together the table below:
Component
Net Income (M$)
Earnings per share (EPS)
# of shares (M)
Price per share
Market Value – Equity (M)
Market Value – Debt (M)
Market Value – Total (M)
– % Debt
– % Equity
Beta (levered)
Beta (unlevered)
Average Beta (unlevered)
Maxwell
17.22
4.20
14.00
20
20
0.60
Barston Notes
9.70
4.50
Net Income / EPS
11.50
# of shares x price per share
7
7
Debt as a per cent of Total MV
Equity as a per cent of Total MV
0.66 as reported in Value Line
Beta (levered) x % Equity
Average of the two Beta (unlevered)
The unlevered beta was the risk associated with the industry. Daniel needed to take that
unlevered beta and relever it to make it specific to Wilson Aviation. To do this, he put together
another table:
Page 3 of 7
Values for Wilson:
% Debt
% Equity
Beta (relevered)
Risk free rate
Market risk premium
Expected equity return (CAPM)
Expected cost of debt
Tax rate
Weighed average cost of capital (WACC)
25.0%
2.0%
6.0%
4.9%
21.0%
It was now all coming together! Daniel could take the unlevered beta and divide it by Wilson
Aviation’s % Equity to get the Beta (relevered). He would then use it in the CAPM to get the
Expected Equity Return using the CAPM. That was the last piece of the puzzle as the already had
all the other factors at hand. He filled in the numbers and when he looked at the WACC, he couldn’t
help but realize that Harlan’s proposed return on his equity wasn’t far off.
This bit of news comforted Daniel. He feared that over time Harlan had been losing the firm
grip he had on his business but now he realized that the old man was as sharp as ever. He was now
convinced that the firm had been in good hands all along and that he would be buying a solid
enterprise with good products, a solid service program, and a pipeline of new controls that would
keep the firm busy for at least a decade if not more.
With the WACC calculated, Daniel turned to forecasting the firm’s income statement.
Harlan had given him the firm’s 2020 financials and between the two of them they came up with an
estimate for the growth of the firm’s two revenue streams: parts sales and service. They also came
up with an estimate of the future growth of the various expense line items.
Harlan told Daniel that the service program showed not only higher revenues but also higher
margins. Daniel said that that was also the case at Boeing, where service was the cash cow for the
business and aircraft and parts sales were almost there to support the service business unit.
That all said, both recognized that both revenue streams relied on the firm’s investment in
research and development (R&D). Looking at the forecasts, they both realized that R&D was
becoming the largest line item in the expenses. It all made sense. In some firms, R&D can reach
20% of revenue and these firms were the ones that had the most success in their markets.
Accompanying the R&D expenses in dollar amounts were salaries and benefits. Both agreed that
the future of the firm was based on its human capital and that to keep the best you had to pay well
and offer good benefits. Not many people would move to central California to live and to get them
to do so, you had to offer them an incentive in their pay package.
Based on his discussions with Harlan, Daniel put together the following income statement
forecast for Wilson:
Page 4 of 7
Income Statement (in ‘000 $)
Growth rates:
Parts Sales
Service Program
Parts Sales
Service Program
Total Operating Revenues
Actual
2020
2,223
2,142
4,365
Salaries and benefits
Research and development
Service expense
Sales and Administrative
Depreciation/amortization
Total Operating Expenses
995
922
565
437
374
3,293
Income before taxes
Income tax expense/(benefit)
Net Income
1,072
225
847
2021
2022
Projected
2023
2024
2025
5.0%
6.0%
5.0%
6.5%
5.0%
6.5%
5.0%
6.5%
5.0%
6.5%
Notes
Increase at a
yearly rate of
4.5%
7.0%
5.0%
4.0%
4.0%
For the income statement, the math was straightforward, for example:
2021 Parts Sales = 2020 Parts Sales x (1 + 2021 Part Sales growth rate)
2021 Salaries and benefits = 2020 Salaries and benefits x (1 + Salaries and benefits growth rate)
2021 Income tax expense = 2021 Income before taxes x 21%
With income statement all done, Daniel put together the forecast balance sheet for Wilson:
Cash and investments
Accounts receivable
Inventory and supplies, net
Other
Current Assets
Other
Total Assets
Balance Sheet
1,934
1,249
1,045
192
4,420
5,932
10,352
Bank Loan
Payables
CPLTD
Other
Current Liabilities
LTD
Equity
Total Liabilities & Equity
4,049
248
44
93
4,434
1,877
4,041
10,352
Working Capital
4,035
Increase at a
yearly rate of
12.0%
10.0%
9.0%
3.0%
Increase at
5.0%
Plug account
Increase at a
yearly rate of
5.0%
1.0%
3.0%
Exclude Bank Loan
It was all now starting to take shape. The income statement forecast allowed Daniel to see
how the firm would be faring going forward. The bottom line for the income statement was robust
and, most importantly, it was feeding the Equity account in the balance sheet. The formula for the
Equity was:
2021 Equity = 2020 Equity + Net Income
Page 5 of 7
The LTD account formula was also straightforward:
2021 LTD = 2020 LTD – 2021 CPLTD
This was because the CPLTD was taken out of LTD and paid out in 2021, thus reducing the
LTD account. That made sense. The Bank Loan, the last debt account, was a balancing account and
consisted of:
Bank Loan = Total Assets – Payables – CPLTD – Other – LTD – Equity
The Bank Loan, if positive, was a working capital loan that allowed Wilson to fund itself
properly. The amount was calculated correctly and the balance sheet balanced – that is, total assets
equaled total liabilities plus equity. If the Bank Loan was negative, the absolute value of it was just
cash.
All the other line items in the balance sheet had their allocated yearly growth rates and they
grew at a good pace as the firm was growing. Finally, the working capital was calculated. Daniel
was careful NOT to include the Bank Loan in the calculation:
Working Capital = Current Assets – Payables – CPLTD – Other
Daniel knew that he had to forecast the balance sheet in part to see how the firm’s accounts
would be faring in the coming years but mostly because he needed the change in working capital
from year to year to generate the FCF.
With the income statement and balance sheet looking good, Daniel then set up the FCF table
to calculate the EV and the value of the equity:
Free Cash Flow Valuation
(in ‘000 $)
Income before taxes
+ Interest
= Income before interest and taxes (EBIT)
EBIAT
– Change in Working Capital
– Change in Other assets
Free Cash Flow (FCF)
PV of FCF = EV
– Existing Debt
= Value of equity
2021
2022
2023
2024
2025
TV
Growth rate
2.5%
He applied the 2.5% growth rate to the perpetuity governing the Terminal Value (TV)
calculation:
Terminal Value = 2025 FCF x (1 + TV growth rate)^2/(WACC – TV growth rate)
Page 6 of 7
He understood that the (1 + TV growth rate) term had to be squared because implicit in the
formula was a discounting of the terminal value by one period. So, if he didn’t square it, the TV
would be as of the end of 2025 and not as of the end of 2026, as he had it laid out in his table. Daniel
knew that Excel would treat the cell after 2025 as 2026 and made this adjustment.
Daniel calculated the FCF as well as the TV. He applied the NPV function to them using the
WACC as the discount rate. He got the EV and then subtracted the value of the 2020 debt. He had
finally gotten the value of the equity of Wilson Aviation!
Harlan would hold 50% of it and Daniel would give him half the value of the calculated
equity to hold the other 50%. It was a pretty sweet deal for both!
Case Questions
Use the Wilson Aviation template to calculate the following:
1.
2.
3.
4.
WACC
Forecast Income Statement and Balance Sheet, including Working Capital
FCF
EV and value of the Equity
Remember to show all your formulas to ensure that you can get partial credit. If you show
only a numerical answer and it is not correct, you will not be eligible for partial credit.
Page 7 of 7
FINANCIAL ANALYSIS
Source: Bloomberg, Capital IQ
Beat Estimates
Missed Estimates
Stock Buybacks
Source: Company filings and team estimates
Source: Bloomberg Pricing & Estimates
Ex. 25a – TJX Historic ROE and Payout Ratio
60%
13.5%
13.0%
50%
12.5%
40%
12.0%
30%
11.5%
11.0%
20%
10.5%
10%
FYE11
FYE12
FYE13
Capital Appreciation
Operating Margins
Source: Bloomberg
FYE14
FYE15
9.5%
Dividend yield
Ex. 25 b – Rev/SF and SF/Store
500
10.0%
23.3
Amount ($ K)
400
23.6
300
23.0
200
22.7
100
22.4

22.1
Revenue/SF
Source: Company filings and team estimates
SF per store
Ex. 26 – Current and Target Number of Stores
Target
Current (3Q ’16)
Marmaxx
0
Homegoods
2000
TJX Canada
4000
TJX Europe
6000
Stable existing store sales and robust new store growth drive organic topline
revenues. We expect existing store revenues to grow at a 6% CAGR during the next
5 years. This assumes a continuation of the constant increases in revenues for samestores of the past 27 quarters. Adding to these will be new, smaller stores, which we
assume will be growing at a rate of 180 per year over the next 5 years. Revenues from
these new stores will grow at a 3.9% CAGR until FY2020. Margins will improve as
TJX opens more, smaller stores near urban areas, where it should sell higher-margin
products (seasonal, beauty, and jewelry) at higher volumes per square foot (Ex. 25b,
26). Overall, we project a 5.9% annual revenue growth rate that will allow TJX to reach
$40B in top-line revenues by FY21 (for more detail, see Appendices 2 through 5.)
Sq.ft. (K)
0%
TJX’s ROE has increased 8.6% from 43.3% (FY11) to 51.9% (FY15). This
increase is mainly due to increased dividend pay-outs (4%, Ex. 25a), share buybacks (2.7%, Appendix 16) and increases in operating margins (1.9%, Ex. 25a),
which are the result of higher revenues per square foot (Ex. 25b). The share buybacks drove leverage (as measured in avg. assets/avg. equity) from 2.58 (FY11) to 2.51
(FY15). These share buy-backs, by virtue of increasing leverage, will drive
shareholders to require higher ROEs. TJX has been able to exceed these higher
expectations due to much higher than average performance. We attribute TJX’s
delivery of higher ROEs over time to its ability to controls costs – viz. as a percent of
sales, COGS fell from 73.1% (FY11) to 71.5% (FY15) and SG&A from 16.4% (FY11)
to 16.1% (FY11) – and asset utilization, as inventory turns increased from 6.1x (FY11)
to 6.7x (FY15).
Trade Secret
As a primarily brick-and-mortar retailer, TJX relies on leased space rather than
owned stores which allow them to optimize store size to changes in demographics
and consumer preferences. We estimate that revenues per square foot (RSF) will
increase at a 1.7% CAGR from $380.5K (FY15) to $414.6K (FY20) while the average
footprint of new stores will fall from 22,500 square feet to 22,000.
TJX will improve margins from 28.5% to 30% as it uses its increasing purchasing
power and an atomized supplier base to drive COGS lower. As a result, we project
EBITDA to grow at a 5-5.1% per year for the next 5 years (Ex. 27).
Source: Company filings and team estimates
50000
40000
Ex. 27 – Gross Margins
29.5%
29.3%
29.1%
30000
28.9%
20000
28.7%
10000
28.5%
0
28.3%
Revenue:
GP Margin
The metrics discussed above – revenue growth, efficient use of store space, and
improved margins- explain, in part, the relentless climb in TJX share prices, as
illustrated in the previous page’s chart. Over the past five years, TJX have beat
estimates fourteen times and missed estimates 5 times. Five times is also the amount
of times that TJX has gone to the markets to buy back shares. While the chart clearly
shows that the share buy-backs do not have an immediate impact on share price, they
do have a long term impact, which we estimate to be $5-6 per share. With a dividend
yield of 1.3%, TJX is out-performing all indices (see bottom of page 1), and according
to our analysis will continue to do so for the foreseeable future. We explain how in the
next section.
Source: Company filings and team estimates
VALUATION
Ex. 28 – Stock Price Football Field
We used a weighted average of discounted cash flows (DCF), comparables, and
leveraged recapitalization values to arrive at a target price of $83.40 – a 18.1% upside
over the current stock price of $70.56 (Ex. 29) We assigned a higher weight to the DCF
because we believe that TJX, a mature company in mature industry, will continue
growing by taking market share from its full price competitors and holding its own
against the online competition. We explain our assumptions in detail below.
Source: Team Estimates
Ex. 29 – Scenario Summary
DCF (55% weight) We used a 5-year DCF model to reflect TJX’s position as a mature
OP retailer. The Base Case, which has a 50% probability, assumes a 4.4% yearly samestore growth while the Bull Case (25% probability) and Bear Case (25% probability)
assume 5.5% and 2.7% growth rates respectively (Ex. 30):
Ex. 30 – Revenue Assumptions
Source: Team Estimates
Ex. 31 – Comparables Summary
Source: Team Estimates
Source: Team Estimates
Our discount rate of 7.8% reflects a beta of 0.8, and we did not modify it despite
TJX’s share buy-backs. We applied a 9.4% risk premium based on the equity market
premium observed during the past 10 years. For more detail, please see Appendix 6.
Source: Team Estimates
Ex. 32 – Peer Debt/EBITDA Multiples
Source: Team Estimates
Ex. 33 – Leveraged Recapitalization
Comparables (40% weight, Ex. 31) We weighed comparables as follows: OP
retailers – 55%, traditional retailers (Macy’s, Nordstrom, etc.) – 40%, and online
retailers (amazon, overstock, etc.) – 5%. The metrics used are EV/Revenue (30%),
EV/EBITDA (30%), Price/FCF (20%), and P/E (20%). For more detail, please see
Appendices 7 and 14.
Leveraged Recapitalization (5% weight, Ex. 32, 33) TJX’s current capital structure
has a 0.4x Debt to EBITDA is equivalent to a 3.4% of debt to market capitalization.
This figure is among the lowest in the industry where the median is 1.8x Debt to
EBITDA. Assuming that TJX may in the future look out for alternative methods to
stock buy-backs in order to increase shareholder wealth, we foresee the company
increasing its debt levels to 1.4x Debt to EBITDA. This would take its debt to about
$5.9B from the current $1.6B. In this case, we want to consider this potential
eventuality yet recognize that it is not a likely scenario, so we have assigned it a weight
of 5%. For more detail, please see Appendix 8.
Ex. 34 – Bootstrap Revenue Forecast
Source: Team Estimates
Ex. 34 – Bootstrap Model of Price per Share
Source: Team Estimates
Bootstrap Statistical Price Simulation (5% weight)
We used regressions to forecast revenues and their probability-based distributions. To
accomplish this, we related a future quarter’s revenue to a reference quarter (3Q10)
using a predictor function. As with all forecasts, there will be deviations, which are
quantified and assigned probabilities as they are normally distributed. We bounded our
confidence intervals at ± 2.5% to get a more granular view of TJX’s future
performance. After doing this exercise, we obtained a lower-bound share price of
$95.20 (blue line, Ex. 34), which

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