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Yell Group Investment Analysis

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FIN 415 Case 3 – Kohler Co Questions

Li Ding

Peihao (Max) Ding

Guanzhong (Kevin) Wang

It is important to understand how Yell’s projected debt affect the valuation. As a rule of thumb, if a firm finances its operations with higher portion of debt, the firm becomes riskier so its investors will require a higher return for their investment. Namely, the cost of equity of the firm becomes higher. We can estimate the cost of equity according to the CAPM model

,[pic 1]

where . We can estimate Yell’s  with the beta and debt-to-equity ratio data of Yell’s comparable firms. Since we were given that , we can justify that  increases as Yell’s projected debt-to-equity ratio increases and hence  also increase.[pic 2][pic 3][pic 4][pic 5][pic 6]

When we use Adjusted Present Value (APV) method to valuate a firm, it makes more sense to apply the cost of equity for the unlevered firm to discount the cash flows on the tax shield. Note that there are two parts of present values in the APV method. One is the present value of the free cash flows to the firm (FCFF) discounted by the cost of equity for the unlevered firm. The other is the present value of the tax deductible part of the interest expenses in the projected years. When we talk about interest, we have taken the cost of debt into account, so if we discount these cash flows with the cost of debt we will double count the required return for the debt financing.

In order to value the value of Yell’s group, we will value its U.S. part of Yellow Book and its U.K. part of Yellow Pages separately. First, we will focus on the value of Yellow Pages. Recommended by Apax/Hicks Muse, we modify the projected weighted average advertisement prices due to the speculation that the U.K. Office of Fair Trading would cap the advertising price growth rate. The new price growth rates in the projected years will be 6% below the inflation rates of 2.4% in 2002, of 2.3% in 2003, and of 2.0% thereafter. We assume that other data of management projections is appropriate. Then we can find the FCFF in U.K. pounds. We apply the forward rate approach and the WACC technique for the valueation, so we first convert the U.K. pounds to U.S. dollars with the currency exchange rate given in Exhibit 11. However does not provide the 6-year forward rate so we need to estimate the rate first. According to the yields on the 5-year and 10-year T-bills in U.S. and U.K., we find the forward exchange rate may increase from 1.4192 dollars per pound in the 5th year to 1.4709 dollars per pounds in the 10th year under the assumption that the higher interest rate in the U.S. will be offset by the depreciation of U.S. dollar’s exchange rate. Then we estimate the forward exchange rate in 2007 to be 1.4673[1]

Table 1. Valuation for Yellow Pages.

[pic 7]

The data used to value Yellow Pages is listed in Table 1 above. The inputs for estimating the weighted average cost of capital (WACC), and terminal value of the firm in 2007 is presented in Table 2 below.

Table 2. Inputs for estimating WACC and terminal value




Risk-free rate (rf)


Yield on 5-year U.S. T-bill, given in Exhibit 11

Expected market return (rm)



Market risk premium (rm – rf)



Debt-to-equity ratio (D/E)


sinceand  from Exhibit 4; assume a constant D/E ratio.[pic 8][pic 9][pic 10]

Asset beta ()[pic 11]


Weighted average of the asset betas of Yell’s comparable firms[2]

Debt beta ()[pic 12]



Equity beta ()[pic 13]


 [pic 14]

Cost of debt


Weighted average of the interest rates listed in Exhibit 8[3]

Cost of equity


 [pic 15]



 [pic 16]

Long-term growth rate


Growth of the total advertising market was stable at around 8% from 1985 to 1999. However, the growth of the classified directories advertising market dropped rapidly from 12% to 6.6% mainly due to new channels for advertisements. As technology improves continuously and provides more and more channels for advertisements, I expect the growth of the classified directories advertising market would continue to drop. Additionally, the US yellow page market had been growing at 4%-5% steadily. Hence, My expected long-term growth is 4% for both U.S. and U.K. market



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