SCENARIO

On the 31st July 2012, Aer Lingus Group plc, an Irish airline, wrote to shareholders outlining its reasons for recommending that shareholders reject Ryanair Holdings plc?s offer to purchase the company. The offer valued Aer Lingus Group plc at ?694 million (?561 million).

The board of directors of Aer Lingus Group plc were unanimous in the view that Ryanair?s offer fundamentally undervalued the company.

Ryanair already owns a 29.82% stake in Aer Lingus Group plc, which was built up during two previous unsuccessful attempts to buy the airline in 2006 and 2008.

Ryanair’s offer is to be investigated by the European Commission over competition worries.

Dear writer:

I will include some additional information that should be used in this assignemnt. Please follow the structure of the assignment.I do not need introduction or conlusion just this:

SCENARIO

On the 31st July 2012, Aer Lingus Group plc, an Irish airline, wrote to shareholders outlining its reasons for recommending that shareholders reject Ryanair Holdings plcâ??s offer to purchase the company. The offer valued Aer Lingus Group plc at â??694 million (£561 million).

The board of directors of Aer Lingus Group plc were unanimous in the view that Ryanairâ??s offer fundamentally undervalued the company.

Ryanair already owns a 29.82% stake in Aer Lingus Group plc, which was built up during two previous unsuccessful attempts to buy the airline in 2006 and 2008.

Ryanair’s offer is to be investigated by the European Commission over competition worries.

REQUIRED

The requirements of the report are detailed as follows:

In your role as Finance Director of Aer Lingus Group plc, fellow board members have asked you to produce a report to assist the company in its defence of the hostile bid from Ryanair Holdings plc.

Valuation Model (20 marks)

1. Produce a company valuation using a free cash flow valuation model. The model should incorporate estimates of the following;

(i) Return on invested capital (ROIC)

(ii) Cost of capital

(iii) Horizon or competitive advantage period

(iv) Expected future cash flow

(v) Growth in future cash flow

(vi) Reinvestment required

This section of the report should be included as an Appendix to the written element of the report. Students may wish to use Excel to produce the model.

Report

The written element of the report should contain three distinct sections.

Section A (20 marks)

In your role as Finance Director;

(a) You will comment on the valuation you have produced, relative to the value of the hostile bid, and;

(b) You will be expected to fully justify the estimates used in your model with regard to the following key elements;

(i) The horizon period chosen

(ii) The difference (spread) between ROIC and the Cost of Capital both during and after the horizon period

(iii) The expected future growth

Section B

Section C (30 marks)

In your role as Finance Director;

(a) You will be required to justify the choice of model used to estimate the Cost of Capital (CAPM) and;

(b) You will be required to justify the estimates used in respect of;

(i) the risk free rate

(ii) the risk premium

(iii) Beta

Issues surrounding the model (CAPM) and the difficulties in estimating inputs to the model should be fully explored with reference to relevant theoretical literature.

Specific requirements

Students will be required to base any figures or estimates used on Aer Lingus Group plc.

Students should assume, for the purposes of the assignment, that Aer Lingus Group plc is all equity financed.

When constructing the valuation model students should carry out some sensitivity analysis to assess the impact that any changes in estimates will have on their valuation. Evidence of sensitivity analysis should be included in the form of additional valuation models included as appendices.

The report should include Harvard referencing. The report is to be completed on an individual basis.

Profit From Operations (Cash Flow) next year (2013) â??49.109m

FAQ Corporate Financial Management Assignment

Where can I find the â?˜correctâ?? Horizon Period?

The term â?˜correctâ?? is open to a significant amount of debate in this context.

The starting point for deciding on the Horizon Period is to read the article â?˜Common Errors in DCF Modelsâ??. It contains a clear idea as to what the minimum Horizon Period should be. This is one perspective.

The article â?˜Thoughts on Valuationâ?? identifies a number of qualitative factors that might help you to arrive at an additional understanding on what might be appropriate for a company like Aer Lingus.

Where can I find the â?˜correctâ?? growth figure?

The article â?˜How to choose between growth and ROICâ?? acts as a starting point for considering this issue. The chapter on growth from Koller is a more detailed consideration of factors driving growth.

Your challenge is to apply some of these factors to Aer Lingus based on your understanding of their current position.

Additionally, the narrative elements of Aer Lingus Group plc Annual Report will give some perspectives on growth.

You can also look at data providers (Reuters, Bloomberg, FT) measures of growth for Aer Lingus across a number of financial metrics, which may also help you to gain some perspective.

Where can I find the â?˜correctâ?? ROIC figure?

The article â?˜How to choose between growth and ROICâ?? acts as a starting point for considering this issue.

The base data given to you with the assignment contains a ROIC of 4.53% this is based on the most recent ROI taken from Reuters. You can use this figure if you wish, but remember this is one source, therefore justification is required as to why you think is most appropriate.

Where can I find the â?˜correctâ?? Cost of Capital?

â?¢ Risk free rate â?? Damodaran is a good starting point in determining what the best measure to use is.

â?¢ Risk Premium (EXMR – RF) – Damodaran is a good starting point in determining what is the best measure to use. Additionally, the survey carried out by Fernandez provides an additional perspective, so too does the ACCA article.

â?¢ Beta – Damodaran is a good starting point in determining what the best measure to use is.

Where can I find the Operating Profit number?

This was given to you as part of the base data. The figure to use in Year 1 of your FCF model is â??49.109 million.

Will the growth, ROIC, and Cost of Capital be the same after the Horizon Period?

The spread or the difference between ROIC and Cost of Capital will be significant during the Horizon Period. During the perpetuity phase of your model, the spread may narrow. This can happen due to the ROIC reducing on its own, the Cost of Capital increasing on its own, or through both variables moving. You have to decide what you feel is most appropriate and justify it accordingly.

In terms of growth, you need to decide if during the perpetuity period when the business is not performing as well as it has done during the Horizon Period what would be the most appropriate impact on growth.

What can I use appendices for?

Given the word count restrictions mentioned above you may need to include additional evidence of research in the appendices.

You will also need to include evidence of sensitivity analysis in the appendices.

Resist the temptation to fill the appendices with irrelevant information. Only items that are specifically referred to in the report should be included.

Do not â?˜bulk upâ?? the Appendices with a multitude of irrelevant documents or screen prints.