Module 6: Cost of Capital and Valuation Regional Airlines - jetBlue

1. Module 6: Cost of Capital and ValuationRegional Airlines - jetBlue Michelle Kelly

2. Three Different Cost of Capitals • Cost of Enterprise Capital • Risk associated with enterprise operations • Not affected by changing from debt to equity financing • Difficult to Measure • Cost of Debt • Risk of Default • Affected by changes in the amount of debt outstanding and maturity dates • Cost of Equity • Risk to Shareholders of receiving distributions • Affected by changes in the amount of debt outstanding and shifting maturity dates • Affected by changes in enterprise value • None are observable but all can be calculated

3. Relationship Between Costs of Capital • Equity is not inherently risk • Risk associated comes from enterprise operations and defaulting on debt • Proper way to calculate cost of equity would be to subtract cost of debt from cost of enterprise capital • However, enterprise capital is difficult to calculate so often add cost of debt and equity to find it

4. Determining Beta-Bloomberg

5. Determining Beta- Other Sources • www. google.com 1.24 • www.nasdaq.com 1.44 • http://investing.money.msn.com 1.24 • http://www.reuters.com 1.02 • http://finance.yahoo.com 0.55 • http://research.scottrade.com 1.00 • http://research.tdameritrade.com 1.00 • http://www.firstrade.com 0.55 • http://finance.comcast.net 1.02 • http://www.zacks.com 1.24 • http://www3.valueline.com 1.25 • http://data.cnbc.com 1.02

6. Determining Beta – Regression Analysis of Monthly Data (1/1/09-2/3/2014)

7. Determining Beta – Regression Analysis

8. Determining Beta • Beta: 1.24 • Supported by Regression Analysis • Supported by other analyst estimates • Higher than Bloomberg Beta but middle ground for other beta estimates

9. Cost of Equity Capital • Based on the Capital Asset Pricing Model • Jet Blue Cost of Equity: • -.3835% +1.24 (8.5%) = 10.16% • 8.5% is the average monthly return on the S&P 500 for the last five years

10. Cost of Debt Capital: Debt Rating • Moody’s • B3 • S&P • B • Fitch • B • All highly speculative ratings which are associated with debt which has a high risk of default

11. Cost of Debt Capital • Annual RNFL • Average: 3.9%

12. Cost of Debt Capital - Alternative • Interest expense/Average amount of interest-bearing debt • Multiply by 1- tax rate in order to get after tax cost • Jet Blue: • Interest Expense 2012: $176 • Average amount of debt: $997.5 • (2012:$950 and 2011: $1045): • Effective tax rate is 39% • $176/997.5 x(1-.39) = 10.76%

13. Cost of Debt Capital • Large variation between the two cost of debts calculated • Pros and Cons to both • RNFL seems low based on the low rating of JetBlue’s debt by credit agencies • Alternative is too high because it does not have adjustments for other forms of debt such as capitalized leases • Use RNFL

14. Cost of Enterprise Capital • VD = $2,360 million (projected 2013 book value of NFL) • VEq = $2,386 million (stock price of $8.50 at February 11, 2014 times 280.750 million common shares outstanding) • Implied VEnt = $4,746 million ($2,360 + $2,368) • 3.9% (2,360/4,746) + 10.16%(2,386/4,746) WACC = 7%

15. Bloomberg WACC

16. Valuing Jet Blue • EATO:1.28 • EPM 4.46% • Assumed Sales Revenue Growth: 5% • Assumed Discount Rate:  7%

17. Questions?