Reference no: EM132755479

Shin Lee was a recent immigrant to Canada and current undergraduate student at the Telfer School of Management. He had some family money to invest and wanted to use the skills he was developing at Telfer wisely. He had heard a great deal about recent turmoil at Bombardier, and this news had piqued his interest. Lee knew often a company in trouble was a good buy, particularly if the future looked bright.

Problem 1: Did Bombardier provide a good investment opportunity? Lee started to do work on a DCF model for Bombardier. He made projections about the Free Cash Flow (FCF) and he was ready to take the present value of the FCF. To do that he realized that he needed to compute the company's Weighted Average Cost of Capital (WACC).

Lee's research indicated Bombardier's Beta was 2.30 and the Market Risk Premium was 5.23 per cent. He set out to calculate the weight of equity for Bombardier based on the closing share price as of December 31, 2019. Share price information was available at Bombardier Investor Relations. By looking at the 2019 Annual Report (available also at the Investor Relations website), Lee could determine the number of shares outstanding of both preferred and common shares (see pages 203 and 205 of the Annual Report) and exchange rates (see page 143 of the Annual Report). The exchange rate is important because the values in the Annual Report are in USD whereas the share prices are in CAD. He will need then to convert the USD values to CAD. He assumed the company's effective tax rate was 19.13 per cent (an average of the last 4 years that Bombardier had a positive tax rate). For the same day, December 31, 2019, Lee researched the Canadian 10-year bond yield at the Bank of Canada, which would be necessary in calculating the cost of equity for Bombardier. He found that this yield was 1.70%.

Lee expected to incorporate the range of preferred shares and their most recent dividend payouts into his cost of capital calculations. He assumes that the growth rate of the preferred shared dividends is zero. When calculating the cost of debt, he would include the company's long-term debt (see page 199 of the Annual Report). For the debt that has no value for December 31st, 2019 (it is represented as a dash) he assumes that the market value is 0 (i.e., it has been paid off). were the best estimates of the market values in USD. Finally, Lee's research on Bloomberg gave him the bond prices for all of Bombardier's long term debt . The bond prices are necessary for the computation of the YTM of each bond with the exception of the "Other" entry, the cost of which for December 31st, 2019 was explained in a footnote (see page 199 of the Annual Report). One issue is how to handle fractional years for bond maturities. For simplicity, he decided to round the number of periods down when computing the YTM of each bond (for the December maturity it is assumed to be at the end of the month so there is no need to round down). So for example, for the May 2021 bond he assumed it has 2 semiannual periods to maturity.

Problem 2: Using his knowledge of finance, he sat down to punch the numbers and calculate Bombardier's WACC.

Table  Bombardier Bond Prices as of December 31, 2019

                                Note                Price
May-21,           6.13%            $104.30
Dec-21,           8.75%              $109.84
Mar-22,            5.75%            $103.24
Oct-22,               6%              $100.06
Jan-23,              6.13%            $102.55
Dec-24,               7.5%               $105.400
Mar-25,               7.5%                 $102.55
Apr-27,                 7.88%                 $103.50
May-34,                 7.45%             $95.00
Dec-26,                   7.35%               $101.48