Chapter 15 Corporate Valuation, Value-Based Management, and Corporate Governance MINI CAS
!ou have "een hired as a consultant to #ulpa $ishing Supplies %#$S&, a compan' that is see(ing to increase increase its value) #$S has as(ed 'ou to estimate the value value o* t+o privatel' held companies companies that #$S is considering considering acuiring) acuiring) But *irst, the senior senior management management o* #$S +ould li(e *or 'ou to eplain ho+ to value companies that don.t pa' an' dividends) !ou have structured 'our presentation around the *ollo+ing uestions) a)
/ist the three t'pes o* assets that compa mpanies o+n) +n)
Ans+er0 Assets-in-place, growth options, and nonoperating, or financial, assets.
")
hat are asset ssetss-iin-p n-plac lace2 3o+ 3o+ can thei heir value "e esti stimat mated2
tangible, such as buildings, machines, inventory. inventory. Usually they are Ans+er0 Assets-in-place are tangible, expected to grow. grow. They generate free cash flows. The PV of their expected future free cash flows, discounted at the A!!, A!!, is the value v alue of operations.
c)
Answer" Answer"
d)
hat are gro+th +th opti ptions2 ons2 3o+ 3o+ can their eir val value "e esti stimat mated2
#rowth #rowth options options are not not tangibl tangible. e. They include include $%&, $%&, such such as as at drug companies companies and genetic engineering companies, and building b uilding customer relationships, such as at ama'on.com. #rowth options are valued using option pricing techni(ues in !hapter )*. hat are nono onoperat rating asset sets2 3o+ 3o+ ca can the theiir val value "e "e esti stimate mated d2
Ans+er0 +onoperating assets are maretable securities and ownership of non-controlling interest in another company. company. The value of nonoperating assets usually is very close to figure that is reported on balance sheets.
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e)
hat h at is the the tota totall valu valuee o* a corp corpor orat atio ion2 n2 h ho o has has clai claims ms on this this valu value2 e2
Ans+er0 Total corporate value is sum of value of operations, value of nonoperating assets, and value of growth options. +o examples in this chapter have a growth option-- this is deferred until chapter )*. &ebt holders have first claim. Preferred stocholders stocholders have the next claim. claim. Any remaining remaining value belongs to stocholders.
*)
1) 4he 4he *irs *irstt acu acuis isit itio ion n targ target et is is a priva private tel' l' hel held d comp compan an' ' in a matu maturre indu indust str' r')) 4he compan' currentl' has *ree cash *lo+ o* 67 million) Its ACC ACC is 178 and it is epected to gro+ gro+ at a constant rate rate o* 58) 4he compan' compan' has mar(eta"le mar(eta"le securities securities o* 177 million) It is *inanced +ith 677 million o* de"t, de"t, 57 million o* pre* pre*er erre red d stoc stoc(, (, and and 617 617 mill millio ion n o* "oo( "oo( eui euit' t')) h hat at is its its valu valuee o* operations2
Ans+er0
*)
V Op
=
V Op
=
FCF 9 -) + g
( WACC − g ) 89 -) + 9.9:
( 9.)9 − 9.9:)
=
789
6) h hat at is its its tot total al corp corpor orat atee val value ue2 2 hat hat is its its val value ue o* eui euit' t'2 2
Ans+er0
Total !orporate Value / V0P 1 23T. 45!. / 6789 1 6)99 / 6:89 million Value Value 0f 5(uity / Total Total - &ebt - Pref. / 6:89 - 6899 - 6:9 / 68*9 million
*)
9) h hat at is its its MV MVA %MV %MVA : tot total al corp corpor orat atee val value ue ; tot total al "oo( "oo( valu value& e&2 2
2VA / total corporate value of firm minus total boo value of firm Ans+er0 2VA total boo value of firm / boo value of e(uity 1 boo value of debt 1 boo value of preferred stoc 2VA / 6:89 - 68)9 1 6899 1 6:9 / 6;9 million
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g)
1) 4he 4he seco second nd ac acui uisi siti tion on tar targe gett is a pri priva vate tel' l' hel held d comp compan an' ' in a gro gro+in +ing g indu indust str' r')) 4he target has recentl' "orro+ed <7 million to *inance its epansion= it has no other other de"t de"t or pre*er pre*erre red d stoc( stoc()) It pa's no divide dividends nds and curr curren entl tl' ' has no mar(eta"le mar(eta"le securities) securities) #$S epects the compan' compan' to produce produce *ree cash *lo+s o* 5 million in one 'ear, 17 million in t+o 'ears, and 67 million in three 'ears) A*ter three three 'ears, *ree *ree cash *lo+ +ill gro+ at a rate o* >8) Its A ACC is 178 and it currentl' currentl' has 17 million shares shares o* stoc() hat is its hori?on value %i)e), %i)e), its value o* operations operations at 'ear three&2 three&2 hat is its current current value o* operations operations %i)e), at time ?ero&2
Ans+er0
9r c / )9B
)
8
7
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-:
)9
89
6 -7.:7: =.8;7 ):.98; <>=.)>* 67);.>78 / Value alue 0f 0perations g)
Vop < / :<9 /
+ •
•
•
|
89 -) + 9.9; 9.)9 − 9.9;
6) h hat at is its its val value ue o* eui euit' t' on a pric pricee per per shar sharee "asi "asis2 s2 Ans+er0
Value Value of e(uity / value of operations - debt / 67);.>7 - 679 / 6<*;.>7 million. price per share / 6<*;.>7?)9 / 6<*.;>.
h)
#$S #$S is also also int inter ereested sted in appl appl'i 'ing ng valu valuee-"a "ase sed d mana manage geme ment nt to its its o+n o+n div divis isio ions ns)) plain +hat value-"ased management is)
systematic application application of the corporate corporate valuation valuation model to all corporate corporate Ans+er0 V@2 is the systematic decisions and strategic initiatives. initiatives. The obective of V@2 is is to increase maret value added 2VA.
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i)
hat are the the *ou *our value drive ivers2 3o+ doe does each o* the them a** a**eect val value2
2VA is dete determ rmin ined ed by four four driv driver ers" s" sale saless grow growth th,, oper operat atin ing g prof profit itab abil ilit ity y Ans+er0 2VA 0P/+0P 0P/+0PA AT?sales, ?sales, capital capital re(uirement re(uirementss !$/operati !$/operating ng capital capital ? sales, sales, and the weighted average cost of capital. 2VA 2VA will improve if A!! A!! is reduced, operating profitability 0P increases, or the capital re(uirement !$ decreases. 4ee the next (uestion for an explanation of the impact of growth.
@)
hat is return return on invested capital %IC&2 h' is the spread "et+een IC and ACC so important2
Ans+er0 $0C! is the return on the capital that is in place at the beginning of the period" +0PAT +0PAT t +) $0C! = t +) !apital t
Cf the spread between the expected return, $0C!t1), and the re(uired return, A!!, is positive, then 2VA is positive and growth maes 2VA larger. The opposite is true if the spread is negative.
()
#$S h ha as t+o t+o divi ivisio sions) ns) Both h ha ave current sal salees o* o* 1 1,777 ,777,, cur currrent e epected gro+th o* 58, and a ACC ACC o* 178) ivision A has high pro*ita"ilit' %D:>8& "ut high capital capital reuire reuirement mentss %C:EF8&) %C:EF8&) ivision ivision B has lo+ pro*ita pro*ita"ili "ilit' t' %D:<8& "ut lo+ capital reuire reuirements ments %C:6E8&) hat is the MVA MVA o* each division, "ased on the current gro+th o* 582 hat is the MVA MVA o* each division i* gro+th is >82
Ans+er0 2VA 2VA t
0P !$ #rowth 2VA
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4ales t -) + g. !$ = − 0P A!! − + A!! g ) g .
&ivision A ;B ;B *= B *=B :B ;B <99.9 <;9.9
&ivision @ 7B 7B 8*B 8*B :B ;B <99.9 <=:.9
l)
hat is the the IC IC o* ea each divi ivisio sion *or *or 58 gr gro+th +th and *or *or >8 gro+th +th2 3o+ 3o+ is is this related to MVA2 MVA2
Answer:
!apital9 #rowth 4ales) +opat) $oic) 2va
&ivision A 6*= 9 6* =9 :B ;B 6),9:9 6),9;9 6 ;< 6;<.; =.)B =.8B <99.9 <;9.9
&ivision @ 68 *9 6 8*9 :B ;B 6),9:9 6),9;9 6 78 678.7 ):.;B ):.*B <99.9 <=:.9
The expected $0C! of division A is less than the A!!, so the division should postpone growth efforts until it improves $0C! by reducing capital re(uirements e.g., reducing inventory and?or improving profitability. The expected $0C! of division b is greater than the A!!, so the division should continue with its growth plans. m)
4he managers at #$S have heard that corporate governance can a**ect shareholder value) /ist *or them the three mechanisms o* corporate governance)
Ans+er0 The three mechanisms are provisions in the charter that affect taeovers, composition of the board of directors, and compensation plans. n)
h' h ' is is ent entrrenche nched d man manage agement ment pote potent ntia iall ll' ' har harm* m*u ul to to shar shareehold holder ers2 s2
Ans+er0 5ntrenchment occurs when there is little chance that poorly performing managers will be replaced. There are two causes" anti-taeover provisions in the charter and a wea board of directors. 2anagement consumes pers" lavish offices, corporate ets, excessively large staffs, memberships at country clubs 2anagement accepts proects or ac(uisitions to mae firm larger, even if 2VA goes down. This is because salary salary and prestige are highly correlated correlated with si'e.
o)
/ist /ist thr three pr provis ovisio ions ns in the the cor corpo pora rate te char charte terr tha thatt a** a**ec ectt ta( ta(eo eove vers rs))
Ans+er0 These include targeted share repurchases i.e., greenmail, shareholder rights provisions i.e., poison pills, and restricted restricted voting rights plans.
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p)
pl plai ain n the the di** di**er ereence nce "et "et+e +een en insi inside ders rs and and out outsi side ders rs on on the the "oar "oard d o* o* dir directo ectors rs)) hat are interloc(ing "oards2
Ans+er0 ea boards have many insiders i.e., those who also have another position in the company company compare compared d with with outsid outsiders ers.. Cnterl Cnterloc ocing ing boards boards are weaer weaer !50 !50 of company A sits sits on board of company @, !50 of @ sits on board of A.
)
hat is a stoc( option in a compensation plan2
Ans+er0 #ives owner of option the right to buy a share of the companyDs stoc at a specified price called the exercise price even if the actual stoc price is higher. Usually canDt exercise the option for several years called the vesting period. !anDt exercise the option after a certain number of years called the expiration, or maturity, date.
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