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Georgii Meshcheriakov 0939950

Marina Poluianova 0986821

Maksym Malovichko 0986794
Loc Minh Nguyen 0948398
Kateryna Rylova 0986764

Case 2

Hand-in date:


BI Oslo
Course code and name:
GRA6538 Applied Valuation
Executive summary
Netscape has a leading position in quickly growing IT-industry. Its strategy, give
away today, make money tomorrow, has lead to a negative bottom line. IPO was
chosen as remedy to the funding problem and the lead underwriters suggested
changing the offering price from $14 to $28 per share. The aim of the analysis is
to determine whether such a change is appropriate given potential risks and
rewards. The discounted future cash flow analysis suggests stock value of $30.91,

implying that, a price of $28 per share is reasonable and should be approved by
the Board.
By offering the browser free of charge for the business-to-customer (B2C) and
selling server software Business-to-Business (B2B) the company has gained 75%
of the market. Despite its first mover advantage stemming from the innovativeness
and user-friendliness brought by the click-and-point browser, Netscapes
position is rather fragile and revenue growth is likely to gradually deteriorate in
1996-2005. Quick IT development and threat of entry will not allow for stable
revenue growth (g) without additional investments in research and development
(R&D) to bring new innovative solutions to the demanding market. Therefore,
before reaching the steady state, g is assumed to follow a pattern: 95%, 80%,
75%, 60%, 55%, 50%, 35%, 15%, 12%, 8% (the analysis assumptions in the
exhibit 1). Using Microsoft as a benchmark, other operating expenses and Capital
expenditure(CAPEX) are assumed to decline to 20% and 10% of revenue
respectively in 2001. To see if the new IPO price suggested by the underwriter is
reasonable a discounted cash flow (DCF) analysis was conducted.
First, Netscapes cost of capital (WACC) 7.81% was calculated (exhibit 2) using
the cost of equity from the CAPM model 11.09%, cost of debt calculated as ratio
between interest expenses and average 2-year debt 8.69% (cost of debt is close to
8.8% - lending interest rate of the US banks in 1995 which proves that the
calculation is correct), debt and equity values from the balance sheet, and the tax
rate 34%.
Next, total equity value was found as the sum of net present value of free cash
flows in the explicit forecast period (NPV FCF) and the discounted terminal value
(NPV TV). The first one is calculated using the indirect method, discounting by
WACC. The second one is found using the key value driver formula assuming 4%
perpetual growth rate following 2005 (exhibit 3 provides all the calculations).
Netscape market value of equity is thus $1.175 billion implying a price per share
of $30.91. This provides evidence that increasing the price to $28 is reasonable.

This price ($28) could also be obtained in a scenario where revenue growth was
constant at approximately 43.61%, which is highly unrealistic in a quickly
changing environment of software industry.
$161 million of capital can be raised after going on IPO, excluding the
underwriter fees. This should allow Netscape to divert necessary cash to product
development to retain its market share and grow revenues. Netscape needs $ 975
mln to cover other operational expenses over 10 years (1995-2005) and $ 11.27
mln as IPO cost (fees to underwriters).
All in call, we recommend accepting the offer of increasing the price to 28$ per
share and believe it is still slightly underpriced, however we believe that future
market fluctuations might disrupt the reasonably high projected growth rate.

Exhibit 1
The analysis assumptions
Cost of revenues

10.4% of revenues


36.8% of revenues

Other operating expenses

decline to 20% of revenues by 2001

Capital expenditures

decline to 10% of revenues by 2001


straight-line depreciation over 10 years

Changes in Net Working Capital

Long-term steady-state growth

4% annually after 2005

Growth rate of sales

95%, 80% ,75%, 60%, 55%, 50% ,35%, 15%,

12%, 8%
Long-term risk-free rate


Tax rate




Exhibit 2
Weighted average cost of capital calculation
WACC calculation
Long-term risk-free rate




Market beta


Cost of equity


Interest expenses

$ 128655

Average 2-year debt

$ 1480665.5

Cost of debt



$ 26056682


$ 16474521

Tax rate




Exhibit 3
Free cash flow and total value calculation