Valuation Problem For Minor League Professional Hockey Team

Valuation Problema Minor League Professional Hockey Team Embarks On An

Valuation problem: A minor league professional hockey team embarks on an aggressive facility expansion that requires additional capital. Management decides to finance the expansion by borrowing $40 million and halting dividend payments to increase retained earnings. The projected free cash flows are $5 million for the current year, $10 million for the following year, and $20 million for the third year. After the third year, free cash flow is projected to grow at a constant 6%. The overall cost of capital is 10%. What is the total value? If the company has 10 million shares of stock and $40 million total debt, what is the price per share? See pages 175–176. As shown in the table below, the free cash flows in perpetuity, leading to a value of $428 million. Subtracting $40 million in debt and dividing by ten million shares gives a per share price of $39. This assumes that in the future, on average, the free cash flows will be paid out as dividends (thus providing value to the shares of stock). Enterprise value = Equity Value + Debt - cash. $428 million = $388 million + $40 million. Notes: Enterprise Value = Market Capitalization + Total Debt - Cash. Cost of debt is the borrowing rate x (1- tax rate). Cost of equity under the CAPM = Risk-Free Rate + (levered Beta x market risk premium). MRP = Expected Market Return on the S&P 500 less the RFR. Levered Beta = Unlevered Beta x (1+ (1-tax rate) x debt/equity ratio). Levered Beta is specific to the company; Unlevered Beta is specific to the sector. WACC is the after-tax cost of debt x % of debt to total capitalization plus the cost of equity x % of equity to total capitalization. Terminal value = Free cash flow / (WACC - Growth rate).

Paper For Above instruction

The valuation of a professional sports team, particularly a minor league hockey franchise, involves applying corporate valuation principles to an entertainment and sports context. This process requires a detailed understanding of projected cash flows, discount rates, capital structure, and industry-specific factors that influence valuation. In this paper, I will analyze the valuation problem, elucidate the key concepts involved, and demonstrate the calculation steps leading to the estimated value per share and overall enterprise value.

The core of the valuation centers on projecting future free cash flows and discounting these to their present value, considering the cost of capital. The hockey team in question is undertaking an aggressive expansion, funded through debt issuance and retained earnings. The projected free cash flows are $5 million for the current year, $10 million in the next, and $20 million in the third year, with a terminal growth rate of 6% thereafter. This scenario exemplifies a common valuation framework where initial cash flows are explicit, followed by perpetuity growth assumptions (Damodaran, 2012).

The first step involves calculating the present value of the explicit forecasted cash flows, which can be accomplished via discounting each cash flow at the company’s weighted average cost of capital (WACC). The WACC incorporates the costs associated with debt and equity, weighted by their proportion in the firm's capital structure. This calculation recognizes the tax shield benefits of debt, making the after-tax cost of debt central to the valuation (Ross, Westerfield, & Jaffe, 2019).

Subsequently, the terminal value is estimated by capitalizing the perpetuity of free cash flows after Year 3 growth at 6%. The formula used is Terminal Value = FCF in Year 4 / (WACC - growth rate). This captures the ongoing value of cash flows beyond the explicit forecast horizon. Discounting the terminal value back to the present adds the perpetuity component to the overall enterprise value (Sterling et al., 2017).

To determine the total enterprise value, we sum the present value of explicit cash flows and the discounted terminal value. In the scenario outlined, the terminal value calculation yields a significant component, with an overall estimated enterprise value of approximately $428 million. From this, subtracting the company's total debt of $40 million results in an equity value of around $388 million.

Dividing this equity value by the total number of shares (10 million) provides a share price estimate of $38.80, roughly $39 per share, consistent with the given data. This valuation assumes the cash flows are representative of dividends paid to shareholders, aligning with the dividend discount model assumptions and market valuation perspectives (Koller, Goedhart, & Wessels, 2015).

Furthermore, understanding the underlying assumptions, such as the cost of debt, cost of equity, beta, and the use of the CAPM model, is essential. The cost of debt is adjusted for tax effects, while the cost of equity depends on market risk premiums and levered beta. The debt-to-equity ratio influences the levered beta, which in turn impacts the WACC. These variables critically shape the valuation outcome and must reflect current market conditions and industry-specific risk factors (Damodaran, 2019).

In conclusion, the valuation exercise integrates multiple financial theories and models to estimate a fair value for the hockey team. It emphasizes the importance of accurately projecting free cash flows, selecting appropriate discount rates, and understanding the firm's capital structure. While simplified, this approach provides valuable insights into the worth of the team and guides management decisions regarding expansion and financing strategies.

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