Advanced Fuel Corporation
1. The type of financing largely depends on 3 factors:
- Financial status of AFC
- Amount of upside gain in a diversified portfolio
- Record of past banking involvement in corporate venturing
Advanced fuels Corporation is still at the early stage of formation, thus it is unlikely to break even in the future years and its probability of bankruptcy is high. Due to the difficulty in classifying loans to friends into either current or non-current liabilities, the exact ratio cannot be calculated. If the ratio is less than 1, then this means AFC will have trouble paying interest repayments if business suddenly fails. Investment banks ...view middle of the document...
As Advanced Fuels is seeking the loan for acquisition of equipment, land and facilities, a liquidation value could be obtained for these assets and used in deciding the amount of the loan.
Discounted Cash Flow Method: The timing and amounts of cash flows and riskiness are the factors taken into account in valuing the firm under this approach. In the DCF approach, historical and financial data and current trends are used to forecast the firm's future cash flow. A discount rate based on riskiness of the cash flow is then determined. The present value of the cash flows could then be calculated. The pro of using this approach is that it takes into account the growth potential of the business. The value obtained is also based on timing and size of cash flows and risks involved. They directly relate to the debt servicing ability of the firm and hence the amount that should be lent by the bank. Replacement Value: This method determining the total cost incurred if the business were started from scratch. This method is not appropriate as it Advanced Fuels is practically starting from scratch.
4. a. Identify risks involved with this venture and how would you reduce them? We must understand how much risk is involved with this business. This helps us to determine the rate of return of our investment. Asking how those risks can be reduced can help us identify the risk management ability of Dr. Aplin.
b. Justify your projected cash flows and explain assumptions involved.
As this is a new business, the accuracy of the projected cash flows is extremely important for us to assess AFC’s ability to generate the promised required return. We must understand the underlying assumptions of those predictions, and how confident is Dr. Aplin about this projection.
c. What is your business strategy to ensure success?
This tells us their business view, what quality employees they will employ, how do they ensure the completion of the five plants on time, how would they market their product, etc! This may give us hints about how well they will perform and whether they are prepared for the venture. Most importantly this can tell us how would they allocate the $55m addition capital.
5. Discounted Cash Flow Approach
Given that: Discount rate = 30%, Terminal growth after Year 6= 10%
Forecasted value of AFC to its equity holders
= PV of net cash flows + Bank loan
Terminal Value = D (1+ g)/ (K-g)
D= net cash flow in Year 5 ($21), K= Discount rate (30%), g= growth rate (10%)
6. Percentage of the common stock required in exchange for the needed $35 million will be: Equity investment required/ Total equity value = Percentage of equity value
7. New assumptions
Terminal growth rate is only 5%, Bank is only lending $10 million, The new terminal value is: (17.7 + 6)(1+ 0.05)/ (0.3- 0.05)=99.5
The equity value of AFC is: PV of net cash flow + bank loan
= 10 + 3.5/ (1.3) + 14.4/ (1.3)2 + 22.5/ (1.3)3 + 24.5/ (1.3)4 + 123.2/ (1.3)5