Nescape Valuation

REVIEW SESSION 6 Home assignment

NETSCAPE'S VALUATION: Assumptions and steps to proceed.

I. Assume an average annual growth rate for Netscape and tell if the recommended offering price of $28 is justified.

1. Take into account the given assumptions:

a. Make your own assumption on Netscape's average annual growth.

b. Total cost of revenues stays at 10.4% of total revenues.

c. R&D stays at 36.8% of total revenues.

d. Other operating expenses decline on a straight-line basis from 81% to 21% percentage of total revenues from 1995 to 2001 so that operating income as a percentage of total revenues is similar to Microsoft's in 2001.

e. Capital expenditures decline on a straight-line basis from 45.8% to 10.8% as a percentage of total revenues from 1995 to 2001 so that capital expenditures as a percentage of total revenues is similar to Microsoft's in 2001.

f. Property, Plant and Equipment straight-line depreciate over 10 years.

g. Changes in networking capital are zero.

h. Long-term steady-state growth of 4% annually after 2005.

i. Long-term risk-free rate=6.71%, risk premium=6%, tax rate=34%.

2. Compute the NPV of the company = Cash flows NPV (1995-2005) + company's terminal value NPV (taking into account its perpetual growth=4%). Use financial information from the Exhibits 1 and 2 of the case.

2.1. Compute the cost of equity.

2.2. Build a table in Excel to calculate the cash flows for 1995-2005:

1995

1996 ...

Revenue - Costs ( R&D, other operating expense) = Operating income

For 1995 take values from the exhibits 1 and 2

For the 1996-2001 period make a forecast based on the 1995 values and given assumptions

Operating income + Net interest income=(Interest Income-Interest expense) �€" Taxes = Net Income (Loss)

+ Depreciation (because it is assumed to be included into costs). Property, Plant and Equipment (PPE) is assumed to depreciate over 10 years on a straight-line basis.

Depreciation for 1995 from Exhibit 3 = 918. Gross PPE in 1994 = 4283 = ("Property and equipment net in 1994") 2447,098+2*918

2

- Investment in Working Capital (calculate for 1995 from the balance sheet and it