Cable and mobile phone companies are competing with each other for the delivery of content and services to the massive consumer market. The management of Channel Company, Inc., a cable company, believes that creating a new joint venture with Horizon Mobile, Inc., a mobile company, will provide a huge opportunity to create value through synergies in R&D and investments required in distribution systems and markets. The new joint venture will have an asset beta equal to the average of the asset betas of the cable and mobile businesses. The joint venture would require a $2 billion investment and would generate after tax free cash flows of about $175 million per year, starting the following year and continuing into the foreseeable future. The joint venture would be financed by a $1 billion issuance of new stock each by Channel Company, Inc. and Horizon Mobile, Inc., implying a 50:50 ownership in the joint venture by each company.
Both the cable and mobile phone sectors are inherently oligopolistic in nature, and both Channel Company, Inc. and Horizon Mobile, Inc. are the only public companies in their respective businesses. There are private companies as well, but no reliable data is available on them. You will therefore be forced to use the data on Channel Company, Inc. and Horizon Mobile, Inc. to conduct all your analysis. Channel Company, Inc., has a market value of equity of $25 billion and a debt to equity ratio of 0.50. On the other hand, Horizon Mobile, Inc. has a market value of equity of $12.50 billion and a debt to equity ratio of 0.25. The equity of Channel Company, Inc. has a beta of 1.75, while the equity beta of Horizon Mobile, Inc. is 0.50. Information on the debt structure of both firms is available due to a recent issuances of corporate debt by both companies, and the returns on debt of Channel Company, Inc. and Horizon Mobile, Inc. are 3.75% and 3.00%, respectively. The risk free rate is 2.50% and the expected market risk premium (the difference between the market return and the risk free rate) is 5.00% for the foreseeable future. Assume that the tax rate is 34%, the interest payments on debt are tax deductible and the tax shield on debt is as risky as the assets of a business. What is the market value of the joint venture?